How to Improve your Long-Term Investment Returns

Is this recent volatility in the stock market bothering you?  I have a simple solution for you.  Just stop looking at it! 

One of the most common traits that the vast majority of us share is that a loss of something hurts more than the equivalent gain (in our case it will be money).  This is because we tend to overvalue things we own.  It’s called the Endowment Effect.  It was famously illustrated in a psychological study where participants were asked how much they were willing to pay for a coffee mug.  The average answer was about $2.  Then they were told that for participating they were given the mug for free.  Then they were told that someone actually wanted to buy it from them and asked how much they would be willing to sell it for (what they thought it was worth).  The average answer was $5 – for the same mug!  This is also why people tend to have a hard time getting rid of possessions and end up hoarding things. 

The Simple Solution

The more you look at something, the more “bad” scenarios your brain starts to come up with, thinking of all sorts of things that could go wrong, creating the urge to get out before you lose money. 

Which of these stock charts looks the best?

If you said #3, you are a wise investor.  But you probably guessed that there was some kind of catch to this.  You’re right.  They’re all charts from the same stock, Church & Dwight (CHD).  The first 2 charts are short periods of time pulled from the long-term chart (#3), showing each of the last two bear markets (2001/2002 & 2008).  This perfectly illustrates how short-term weakness is a long-term buying opportunity, not a time to panic sell.  

If you’re looking to become a better long-term investor, all you need to do is: do less.  Here’s Paul Rudd as Kunu to explain:

Your perspective should match your investment objectives.  If you’re a long-term investor, then you should be looking at the investment markets from a long-term perspective, not each day or even week-to-week.  Step back and zoom out.  Better yet, don’t even look at it!  If you look at your investment portfolio more often than 1x per month, you’re looking at it too often.  We’re hard wired in some unique ways, many of which are to our disadvantage.  This is how lessons from behavioral finance can help you become a better investor. 

Daniel Khaneman, a pioneer of research in behavioral finance and psychology, has explained this perfectly:

“If owning stocks is a long-term project for you, following their changes constantly is a very, very bad idea. It’s the worst possible thing you can do, because people are so sensitive to short-term losses. If you count your money every day, you’ll be miserable.”

Two Takeaways: 1) A drawdown (unrealized losses) is not “losing money.”  You don’t actually lose money unless you realize the loss by selling.  And 2) 15% to 20% drawdowns are the norm for stocks. 

A weekly timeframe chart is much better than a daily chart, a monthly is much better than a weekly, and best yet is a quarterly chart.  I prefer to use monthly and quarterly charts when timing the purchase of stocks.  Look at how smooth this chart looks:

Church & Dwight (CHD) – 20 years, quarterly 

I’ve found that the 10 quarter EMA and 16 quarter EMA work really well for long-term places of support.  And the 40 quarter EMA (not illustrated) is the best entry you’ll probably get for the rest of your life.  That’s where most stocks bottomed in the spring of 2009.  This is because really big money (like pensions, insurance companies and endowments) that invest with a long time horizon will do most of their buying on these large dips back down to the long-term moving averages.  

Only 6 ideal times to buy the stock in 20 years

If you zoomed out and only referenced quarterly charts to aid in your investment decisions, I’d be willing to bet that:

1. You would be more patient and not bothered by short-term fluctuations
2. You would trade less (fewer decisions, fewer transactions)
3. You would get better entry and exit prices

It also helps by putting things in perspective to show how those 10% to 20% dips that occur almost every year are normal and that it’s best to wait for them to occur before buying.  If drops in the market make you feel panicky and you’ve had issues of selling at low points, now you can properly view those dips as buying opportunities.  You flip the script by taking a step back and utilizing a long-term perspective. 

Thanks for following and stay calm during these periods of higher volatility!

Nick