SAFT ON WEALTH: The wisdom of exercising patience

March 1, 2012

March 1 (Reuters) – “Don’t just do something, stand
there!” might just be the best least-followed advice in
investing.

If there is one statistic that is, if anything, more
depressing than the last empty decade of equity returns it is
the fall and fall of average stock holding periods.

While the average holding period of a NYSE-traded stock was
10 years in the late 1930s the trend since 1995 has been down
and down, driven by ever more frenetic trading. By 2010 the
length of time the average share is held is down to a mere six
months, according to NYSE data, a real testament to the eternal
triumph of hope over experience.

To be sure, the rise of high frequency trading has
played a role in driving down average holding time, but others
have become more active traders too. Estimates vary, but the
average domestic equity actively-managed mutual fund in the U.S.
has an annual turnover rate of between 89 and 130 percent.

This may be great for the brokerage and mutual fund
industries, but for investors it is just about the opposite of
what should be happening.

“Be patient and focus on the long term. Wait for the good
cards. If you’ve waited and waited some more until finally a
very cheap market appears, this will be your margin of safety,”
famed value investor Jeremy Grantham of GMO wrote in a note to
clients.

“Now all you have to do is withstand the pain as the very
good investment becomes exceptional. Individual stocks usually
recover, entire markets always do.”

The poker metaphor is apt. Like playable poker hands, great
investment opportunities don’t come along that often, certainly
far less often than we would like. The natural tendency, then,
is to try and force things by assuming that our jobs as
investors is to always be fully invested and to simply choose
the best available option.

While cash in a portfolio is a wasting asset, losing
purchasing power to inflation over time, it is also extremely
handy when opportunities actually present themselves. The less
clarity there is about the outlook, and right about now there is
very little, the higher the option value of cash.

LOW CONVICTION, HIGH ACTIVITY

And yet so many investors carry on doing a lot of low
conviction trading, as if they can somehow make up in volume the
lack of excellence in their individual investment ideas.

That’s natural, as human beings tend to favor activity over
observation, though that is a strategy that perhaps worked
better for our ancestors seeking food sources on the primordial
savanna then it does for an investor screening stocks.

This tendency is doubly true for professional money
managers, who feel pressure to appear to be working hard and who
may benefit from fee-generating activity. Grantham sees the
freedom from this as a key advantage individuals have over
professionals, though his own career demonstrates that you can
be successful and patient.

It is also true that the obsessions of the quarterly company
earnings cycle can foster a short-term volatility-oriented style
in investors who should be thinking in years not months. Much of
what gets written about stocks by analysts and discussed on
television turns out to be so much noise, background static,
that is best tuned out. This does not mean that earnings beats
and misses are to be ignored, but that it is really easy to get
mesmerized by the expectations machine that is financial markets
and get sucked, emotionally, into trading too often.

The other key thing to remember is that patience is
important as both a buyer and a holder of shares. It is
important to wait for your margin of safety in valuation before
buying, but as a holder it is also important not to sell too
quickly when the market goes against you.

And of course, the one sure thing in all of investment is
costs. When you make a trade the losses or gains you may get in
the future are only a matter of speculation and conjecture, the
execution cost of the trade is the only thing that is inevitable
and easy to measure.

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