“The Persistency of Memory” by Salvadore Dali. Source: Museum of Modern Art
Everyone claims to be. When the market is high, they claim that they’re not worried about a few small fluctuations. But if stocks fall 5%, you’d think we just declared war on the Republic of Freedonia. Everyone wants to get out—but only for as long as the market is down. Then they’re long-term investors again.
The problem comes because we don’t think about what we have. We think about what we’ve gained or lost. For example, when folks get a quarterly investment statement, they don’t look at their total wealth. They look at how it has gone up or down. And we worry more about the downside than we’re excited about the upside. Psychologically, it hurts more to lose something than it feels good to win. That’s why the status quo tends to be more popular: change always implies that something could go wrong—something that’s working right now.
Risk aversion. Source: Wikipedia
This gives truly long-term investors an edge. If you can look beyond the weekly or monthly squiggles and jiggles, you can invest with broader financial and economic trends in mind. For example, right now the “earnings yield” of the broad market is about 5½ %. That’s the earnings of an average company divided by its market capitalization. And firms can borrow money at about 3½ %. It makes sense in this environment for corporate treasurers to issue bonds to buy back their shares. And that’s exactly what’s been happening for the past five years or so. As long as rates stay low and earnings hold up, this trend should continue.
The rewards of long-term thinking are better returns and the peace of mind that comes from being on-track to reach your financial goals. But you don’t want to be too long term. After all, as John Maynard Keynes once said, in the long run, we’re all dead.
Douglas R. Tengdin, CFA
Chief Investment Officer