Source: John Snape via Wikimedia Commons.
More than half of all American adults have investments in the stock market. Yet the average investor tends to underperform major market indexes in time frames ranging from one year to more than two decades. How can this be? Some of this underperformance is due to the fact that many investors simply don't have enough resources to take advantage of good buying opportunities, but by far the largest reason is psychological. We're our own worst enemies.
We human beings are very good at behaving in ways that ensure our short-term survival, but few of us have developed the long-term, big-picture perspective necessary to hang on to good investments for the long haul. Many investors undermine themselves with their narrow, shortsighted viewpoints. If you don't think you're one of them, consider whether you've said or thought any of the following things -- and if you have, start changing your way of thinking so you can improve your odds of long-term investing success.
"Tightening into a cup-and-handle" (and other technical-trading jargon)
I've talked to a number of technical traders over the years, and I'm connected to dozens (if not hundreds) on LinkedIn, so this first statement is in no way meant to disrespect trading. However, it's important to distinguish short-term trading from long-term investing. The former is a type of speculation that's rarely connected to business fundamentals, while the latter absolutely depends on understanding those fundamentals, both in the present and for the future.
Investors don't need all of this to succeed.
Source: Rafael Matsunaga via Flickr.
Technical trading involves a lot of jargon that attempts to find patterns in the randomness of daily stock movements. Humans are so good at finding patterns in things that we often invent patterns to fit random events. This is a psychological fallacy called false pattern recognition, or apophenia. It takes a dedicated mind with a high tolerance for volatility and risk to be a trader, and most people who try their hand at it lose money.
Investing, however, can be as simple as buying a low-cost index fund -- hopefully one that pays a dividend -- and holding on to it for years. It's far less stressful and far more likely to produce gains for most people. Fred Schwed, Jr.'s book Where Are the Customers' Yachts? has a classic quote on the distinction between these two methods of wealth-building: "Speculation is an effort, probably unsuccessful, to turn a little money into a lot. Investment is an effort, which should be successful, to prevent a lot of money from becoming a little."
"I need to double my money in two months!"
I've had a number of friends and relatives ask my opinion on the stock market over the years, and the questions tend to identify the asker as either a patient investor or a short-term speculator. Anyone who asks how they can double their money in a short period of time falls squarely into the speculative camp. Questions like that demonstrate not only a lack of patience, but also a disconnection between ambition and reality.
There probably are some ways to double your money on a short time frame, especially if you start out with a small amount of money and a whole lot of work ethic. But people who earnestly ask about doubling their money in the stock market in a couple of months are not generally interested in taking that route. They just want to speculate. To get that kind of return, they might as well go the nearest casino and let it ride.
Bad news doesn't mean the world is ending.
Source: Flickr user D.F. Shapinsky.
"Oh, no! My stock is down today!"
Even dedicated long-term investors can get caught up in the market's day-to-day gyrations. A friend and I both discussed and then purchased the stock of a fast-growing online bank six months ago with the intention of holding on for at least a few years. He often brings up its daily performance in our conversations, but he will focus far more on bad days than good ones. That stock is up by 75% since we bought it, and I expect that it will gain far more over the long run, but my friend has focused on every 2% drop along the way.
Long-term investors often look to Warren Buffett for inspiration, in no small part because he's well-known for sticking with good stocks through bad times. Buffett bought a stake in The Washington Post in 1973, and it promptly declined by 25%. But because Buffett knew that the company's real value was well above its share price, he reacted with calm optimism: "What we had thought ridiculously cheap a year earlier had become a good bit cheaper as the market, in its infinite wisdom, marked [the Post's] stock down to well below ... [its] intrinsic value."
Buffet has famously said that "price is what you pay, [but] value is what you get." So long as your calculations show that the price of your stock -- whether it's a cheap dividend-payer trading at a discount or a high-growth stock with huge potential -- is below what you think its true value should be, there's no reason to panic over a drop, whether it's 2% or even 20%.
"This is what's going to happen."
Anyone who tells you they know with absolute certainty that something will happen in the future has either inside information or a time machine. We can guess, predict, or assess the probabilities of something happening, but no one can truly know what's going to happen. Anyone who exhibits absolute certainty in their position -- whether it's on stocks, politics, science, or anything else -- usually winds up clinging to outdated ideals when the world changes.
The world has a way of surprising all of us, no matter how educated our estimates and how plentiful our data. Words like "might" and "may" and "could" are sometimes called "weasel words" because they grant the appearance of specificity to vague claims, but this is the only sort of word we can really use about a future we can't reliably predict. Great investors know that nothing is set in stone, and they're always willing to change their minds if compelling evidence emerges.
