The most important lesson in investment

Near the start of this series of articles, we pointed out the five major advantages you have over the City.

Among these, we pointed out that – unlike a professional fund manager – your job isn’t at stake. Nor do you have to beat or match a particular return (or ‘benchmark’ in the jargon). And you don’t have to stick to any one type of investment either.

These are all huge advantages. But they can be summed up in one sentence.

If there’s one lesson to take away from  these articles, it’s this: most of the mistakes that you have made, are making, or ever will make as an investor, boil down to worrying too much about short-term performance.

If you want to be a successful investor, think long-term

That sounds easy. In fact, you probably already think you do think long-term.

Yet everything in the investment world, and everything in your own psychological make-up, is lined up against long-term thinking.

A friend tells you that he made a load of money by backing some little biotech stock, or some gold explorer in one of the ‘Stans. Even though you know at the back of your mind that even if he’s telling the truth, the rest of his portfolio is probably up the creek for the year, you immediately feel a pang of envy, and the need to compete. So you go out and buy some equally dodgy stock, and it doesn’t pay off.

Or you watch the rolling financial news. There’s a lot of red on the screen. All the pundits are talking about Europe defaulting, or the US sailing over the fiscal cliff. The share you bought just last week has taken a pretty heavy hit. And although you bought it ‘for the long run’ and nothing has changed, you sell in a panic.

This chopping and changing because of short-term noise is probably the cause of more investment pain than anything else. Indeed, Tadas Viskanta, who writes the Abnormal Returns log, even suggests that “consistently following a sub-optimal investing strategy is far preferable to flitting from hot strategy to the next”.

It is not your aim to make a 20% return by the end of next week, or even the end of next year. Your goal is probably to make enough to retire comfortably, or perhaps to send your kids to school or university. Whatever the goal is, write it down.

Remember: every time you make an investment, it costs you some of the money that you’re meant to be saving. You need to earn that cost back before you even start making a return. That makes it just that little bit harder to reach your end goal. So you need to have a really good reason to make an investment.

So as long as you know your long-term goals, it will be harder for irrelevant outside events to distract your from the task at hand.

You’ll still make mistakes, of course. The good news is – as Viskanta notes – that according to at least one recent Harvard research paper (from John Campbell, Tarun Ramadorai, and Benjamin Ranish), investors can learn from their mistakes. The team looked at investors in Indian equities, and found – in short – that the longer an investor had been investing, the fewer common investment mistakes they made.

The sooner you start investing, the sooner you’ll start learning. So what are you waiting for?

• This article is taken from our beginner’s guide to investing, MoneyWeek Basics. Everything you need to know about how to invest your money for profit, delivered FREE to your inbox, twice a week. Sign up to MoneyWeek Basics here
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  • MichaelL

    Always worth a read:

    http://johncbogle.com/wordpress/

    … will be interesting to see how funds like the Troy Trojan fund compare against trackers in the next few years. Certainly I find their ‘Spectrum’ fund a bit odd.

  • Ed

    very good article, especially the point about the longer you have been investing the fewer mistakes you make. Also the ability to resist selling during market sell offs. I think this is especially true today due to the actions of hedge funds and computerised trading.

  • Ed C

    In the long term all of us will be dead.

  • Beta adjusted

    I completely agree with this: when you buy a share, you are buying a stake in a company. Most investors want to get rich quick, this is why high growth stocks are generally overvalued (there is academic research showing that historically this has been a very persistent phenomenon). So you should target boring companies which exhibit steady growth characteristics e.g. tobacco stocks. If your tobacco stock has an eps growth of ~10% pa and a free-cashflow yield of ~10% then you should enjoy the compounding effect of 10% pa which will give you a return of ~160% over 10 years. Over 30 years, you would make *16x* your original investment. Of course in some years growth will fall above and below 10%, and the market will decide that that growth is worth a greater/lesser amount (and interest rates etc. will change), so you need a minimum holding period of 5 – 10 years (unless the story changes).

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