The rise of long-term thinking

By Felix Salmon
January 5, 2014

Morgan Housel has penned a rather odd column to mark the new year, declaring 2013 to be the year that “long-term thinking” died, with “his last true friend, Vanguard founder Jack Bogle,” at his side.

The weird thing about this column is that long-term thinking isn’t dead at all; in fact, it’s never been healthier. Housel did manage to find a trader on CNBC exhibiting symptoms of short-term thinking — but that’s what CNBC does, and in fact it’s possible to use CNBC’s ratings as a reasonably good proxy for the general prevalence of short-term thinking. Guess what: they’re at their lowest point in 20 years, with the channel reaching just 38,000 viewers over the course of a day. That’s a really tiny niche. A potentially profitable niche, to be sure, but tiny all the same.

Meanwhile, long-term thinking’s true friends at Vanguard have never been healthier: the Vanguard Total Stock Market Index Fund is now the largest mutual fund in the world, having overtaken the Pimco Total Return Fund in October, and Vanguard’s total assets under management are jaw-droppingly huge: they started last year at $2 trillion, and were already over $2.5 trillion by the end of June. I wouldn’t be surprised if they were at or near $3 trillion by now. It’s pretty safe to say that substantially all of that money is being invested according to the tenets of long-term thinking — and that it vastly exceeds the amount of money being traded on a daily basis by the 38,000 viewers of CNBC. (They’d need to have $80 million each to get to $3 trillion; and while CNBC viewers might be rich, they’re not that rich.)

The height of short-term thinking, when it comes to investing, was surely the dot-com bubble, when everybody wanted to be a day trader, and everybody believed in the greater fool theory. When the dot-com bubble burst, individuals (outside a core group of hobbyists) pretty much gave up on stock-picking and short-term trading. With hindsight, we can even say that the dot-com burst was very well timed to prepare America’s investors for the financial crisis: once they had lived through 1999-2001, they grew up, and ended up responding to the crisis in a surprisingly mature and sensible manner. Here, for instance, is a chart of ETF flows during the crisis:

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What you’re looking at here are some of the most torrid months that stock-market investors have ever seen. Just look at the monthly return figures on the S&P 500, from September 2008 through February 2009: -9.2%, -16.8%, -7.5%, +0.8%, -8.6%, -11.0%. Add it all up, and you get a stomach-churning 42% drop in the market — more than enough, according to conventional wisdom, to spark a major panic among retail investors. But what did they actually do? They ended up putting a net new $90 billion into ETFs over the course of those months.

Or, here’s a chart of mutual fund flows — a chart which naturally exaggerates outflows, since there’s a long-term secular trend out of mutual funds and into ETFs. Again, there’s no real sign of panic during the financial crisis: there was selling, to be sure, at a time when Americans found themselves in sudden need of liquidity, but you’re not seeing any short-term thinking here: you’re not seeing people trying to time the market. More generally, the main lesson of this chart is how small all the numbers are. Compared to the trillions invested in the stock market, weekly flows in the single-digit billions are pretty small beer, and show that nearly all investors, nearly all of the time, are doing the sensible buy-and-hold thing. When flows are small relative to stocks, that bespeaks long-term thinking, rather than short-term thinking.

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This is not the impression that you get from talking to professional financial advisers, of course, most of whom paint themselves as a desperately-needed bulwark protecting investors from their base instincts. And it’s not the impression that you get from reading scaremongering stories about high-frequency trading, or misleading statistics from the likes of Housel, who says that the average stock holding period fell from eight years to five days between the 1960s and 2010. The problem with such numbers is that averages are little use to us here: a very small number of high-frequency algobots, who can hold their positions for less than a second, will skew the averages to the point of meaninglessness.

Indeed, a big reason for the rise and rise of private markets, and the ever-increasing amount of time that companies wait before they go public, is precisely that there is an unprecedentedly large pool of long-term patient money out there, willing to tie itself up in private-equity and venture-capital funds for five or ten years or longer. Individuals are looking for investment advice not so much from the braying noisemakers on CNBC, but rather from institutions with quasi-permanent capital pools: endowments, foundations, sovereign wealth funds.

Or, to put it another way, the war has pretty much been won at this point, and retail investors have got the message. They understand the superiority of passive investing, and they understand the importance of long-term thinking: none of these things, any more, are remotely difficult or counterintuitive concepts. Housel’s column is in effect an attempt to persuade the sensible majority that they’re some kind of beleaguered minority. In reality, however, long-term thinking is alive and well and utterly mainstream. Which should good news for everybody, with the possible exception of CNBC.

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Comments
4 comments so far

Hi Felix,

pardon my ignorance, but I don’t understand how your conclusion about a renewed boom in long-term thinking flows from the evidence presented, particularly in light of the large amount of research that shows the average retail investor receives returns significantly below that of the average mutual fund because they push money into and take money out of markets at exactly the wrong times (e.g. Dalbar).

If anything, the flood of money heading into this fund should be a signal of significant caution about future returns!

Instead, the evidence is more consistent with another conclusion: that investors continue to abandon traditional actively managed mutual funds in favour of ETFs and passively managed index funds. This is also an ongoing “war” in the industry, but one where there does seem to be some movement in the trenches in recent times.

Finally I would note that for every buyer of stocks (e.g. The Vanguard Total Market Index Fund) there is a seller, some need to be cautious about any indications that “money is rushing into the market”. Unless we are talking about stock issuance, then the total amount of ,only invested in the stock market, or any other market, stays the same.

Posted by dicerosMan | Report as abusive

Putting the actions of individual retail investors to one side, let us look instead at the actions of the fund managers? Is the average asset holding period trending up or down for these huge funds?

Posted by wtpayne | Report as abusive

“When the dot-com bubble burst, individuals (outside a core group of hobbyists) pretty much gave up on stock-picking and short-term trading.”

That’s funny! :) During the dot-com bubble and burst, I was primarily invested through mutual funds. Those funds were hammered over a two-year period, especially the actively-managed funds (from three different managers) that were purportedly conservative, value-oriented funds.

It was the dot-com bubble that caused me to question why I was paying other people to lose my money, and perhaps the biggest reason why I made an effort to learn stock-portfolio management (of which stock-picking is only one aspect). As a result, I did much better in the 2007-2008 crash.

Posted by TFF | Report as abusive

@diceros, he is looking at equity mutual funds. Most small-time individuals invest this way, so the cash flows for mutual funds are a proxy for this group.

If cash is flowing into equity funds, then somebody else is selling — presumably institutional and high-net-worth investors who invest directly. I’ve been steadily taking profits off the table over the last couple years, and I’m sure others have as well.

As you note, the small-time investors typically have terrible timing. Positive flows into equity funds is often a signal that the market is about to crash.

Posted by TFF | Report as abusive
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