"Live fast, love hard, die young." Sounds like a Rolling Stone article, right? But no -- this headline came from The Economist, regarding a study that examined why women around the world live longer than men. One possible explanation: Males tend to compete for female attention, and the improved skills evolution has given them in this regard may have come at the cost of longevity.
The study in question compared 35 monogamous and polygynous species of birds and mammals. In most of the polygynous species, the study found that males had shorter life spans than females. This was not the case in the monogamous species.
Polygynous and monogamous investing
What does this have to do with investing? Consider polygyny, where males have multiple wives or female partners, and monogamy, where males choose a female and stick with her. In the stock market, some investors are always looking for the next great pick for their portfolio, selling off some holdings in order to make room for new ones. Conversely, other investors choose their stocks more carefully, aiming to hang on for the long haul.
The latter group tends to perform better. Business professors Terrance Odean and Brad Barber studied the trading activity of more than 66,000 individual investors from 1991 to 1996. They divided the investors into five groups, based on trading frequency, and found that the most frequent traders trailed the least active group in performance by more than 5% per year.
That's a big difference. If you have $100,000 and it grows at 8% per year for 25 years, you'll end up with about $685,000. If it grows at 13% annually instead, you'll ultimately have more than $2.1 million.
Behind the curtain
What makes active traders underperform their less active counterparts? Barber and Odean cited overconfidence as a major factor. In an article in the American Economic Review, Odean explained that:
The more overconfident an investor, the more he trades and the lower his expected utility. ... Overconfident investors ... have unrealistic beliefs about their expected trading profits ... at the worst, overconfident investors believe they have useful information when in fact they have no information.
Too often, we invest in a company based on a mere handful of interesting facts or promising signs. If a company earned $250 million in profits last year, and the "record profits" it's trumpeting this year are $251 million, the increase hardly lives up to the hype. If a company's new drug clears phase 2 clinical trials, it's not a slam dunk to clear phase 3 as well.
Such deceiving appearances hold true in the dating and mating world, too. If you're hunting for your next partner, you may be swayed by a fancy car or an impressive degree. But the person may be deep in debt or lack common sense. We shouldn't get too confident about potential partners -- or investments -- until we've absorbed a lot of information about them.
The information conundrum
Of course, that's easier said than done. According to Odean:
Investors face a formidable challenge when looking for a security to buy. There are well over 10,000 securities to be considered.... Securities that have performed unusually well or poorly are more likely to be discussed in the media, more likely to be considered by individual investors and, ultimately, more likely to be purchased.
This is not a great recipe for success. If a stock is in the news after a recent steep run-up, it may have little room for future growth in the short term. If it has tanked recently, it might be a bargain -- or it might be in deep trouble, about to fall more. Again, more research is required.
Among other qualities, Fools should seek companies with:
- Powerful brands and other strong competitive advantages.
- Healthy balance sheets.
- Talented management.
- Rising revenue and earnings.
- Falling debt.
Don't wear yourself out dashing from stock to stock, running down your chances to enjoy decades of compounding growth. You're better off finding a relatively small number of thoroughly researched stocks, and sticking with them for the long haul.
If that's too much work, a simple index fund can earn you respectable returns in the long run. But for those who can find the best stocks, even greater rewards are possible.