I talk to a lot of individual investors, and if there’s one thing they hate more than anything else, it’s watching their shares fall in price.
“I bought this thing and then it went down. I should probably sell it,” they say.
In fact, the only thing that comes close to producing the same level of angst is watching their shares rise in price.
“This stock has doubled since I bought it. I should probably sell it,” they say.
Don’t laugh. This is how many investors think. They are always looking for an excuse to do something. That’s because they have been led to believe that the secret to investing success is to “play” the market.
When a stock falls, they worry that the business is in trouble, so they sell to avoid further losses. Conversely, when a stock rises, they worry that their paper profit will be vaporized by some unknown threat, so they “lock in” their gains – just to be safe. The idea that doing nothing may be the best option doesn’t occur to them.
There is always a better stock, a surer bet, a bigger payoff somewhere else.
It’s not their fault. The media are full of talking heads advising them to buy this and sell that. When was the last time you saw a guest on CNBC say: “I firmly believe, in light of the Fed’s latest statement, the financial turmoil in Europe and the Dow’s rising price-to-earnings ratio, that people should do absolutely nothing.”
Doing nothing is boring. Trading is sexy. It makes you feel in control. Thanks to mobile technology, you can even buy and sell stocks on your smartphone, just like the E*Trade baby. The question is: Why would you want to?
Sure, there are occasions when trading is warranted – when a company’s outlook changes fundamentally, for example – but I believe that many retail investors are far too active for their own good. Trading excessively drives up commission costs and taxes, and it can have corrosive emotional effects, too, as people look back with regret at the trades that didn’t work out.
Perhaps most important, an obsession with trading can lead people to sell stocks prematurely, causing them to miss out on gains they would have achieved had they simply been more patient. I have seen this countless times.
So what is the cure for trading too much?
It starts with careful stock selection. I’ve said it many times before, but one of my favourite Warren Buffett quotes is: “If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes.” By sticking with large, entrenched, dividend-paying companies that you are confident will be thriving 10 years from now – and ideally much longer – you can minimize the chances that one of your stocks will implode.
Changing the way you think about the stock market is also critical. For traders, the market is where the action is; it’s where the fast money is made (or lost). For investors, the market is simply a mechanism for acquiring stakes in businesses that they intend to hold for long periods. It is a crucial distinction. If you are a long-term investor, the second-by-second pricing that the market provides is largely noise.
If you owned a rental apartment building, would you obsess about the market price every day? Probably not. You would be more concerned with making sure the units were occupied, the tenants were paying their bills and the building wasn’t falling down. Similarly, as a long-term investor, you should think like an owner; your main concern should be that the business is sound, sales and profits are growing and the dividend cheques are arriving reliably (and, ideally, growing every year). If these things are happening, the share price will take care of itself.
Your job is to just get out of the way.