By: Tim Bennett
04.10.2018
Successful long-term stock picking and marathon running have something in common, as Tim Bennett explains in this week’s video.
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How stock pickers are led astray
Successful stock picking is much less glamorous than it is sometimes portrayed in films and in novels. And that’s part of the problem for long-term investors. So, here is a quick recap on five ways you can turn a good strategy into a bad one.
Lack of discipline
Eliud Kipchoge recently smashed the world marathon record. He was asked afterwards to reveal the secret of his success. His reply is interesting a relevant in many other fields, including investing;
In short, we are pretty bad at creating a long-term plan and then sticking to it without deviation. Far from being like “watching paint dry” as a Nobel prize-winning economist once put it, we seek excitement and take risks. This is one of the bigger mistakes we can make.
It also helps to explain why stock pickers generally get better with age – they have learned to reign in the impulsive behaviour that seeks short-cuts and “quick wins” in favour of hard work, structure and method.
Noise
I have covered this point in more detail elsewhere but it is worth repeating – we are bombarded with reason to trade in and out of stocks from all kinds of sources. And thanks to social media in large part, we also suffer from short attention spans. If in doubt, therefore, do not rely on the media, adverts or your digital news flashes when it comes to investing.
Emotional bias
Our natural instincts when it comes to short-term survival can be unhelpful when it comes to investing. There are countless examples but here is a short reminder about a few of the most common examples. Perhaps the most important aspect of this is to realise that everyone succumbs unless they have designed mechanisms to overcome these tendencies;
The risk is particularly high at the moment (October 2018) as investors look back on one of the longest bull runs in history.
“Skewness”
This is a bit of jargon that refers to the fact that the returns to good stock picking can be huge, but only if you recognise a key fact about the stock market – winning stocks tend to win big and not owning them is therefore costly. For example, a study by Henrik Bessembinder at the Arizona State University of US stocks from 1926 to 2016 revealed that a relatively small number of firms deliver most of the stock market’s gains.
For undisciplined investors, however, there are risks with trying to follow this approach too rigidly;
In short, portfolio construction requires a blend of skills if we are to avoid chasing winners and ending up with a very skewed stock distribution that may be totally unsuited to a challenging market.
The temptation to trade
The fact that it is now cheaper than ever to trade stocks online is to be applauded, except in one regard – this creates a huge temptation to do just that. The danger is we buy stocks for no other reason than that we can and then jettison them on a whim at the first sign of trouble. This “churn” can do serious damage to our long-term returns.
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