Episode Details

I find it ironic that the two common financial mistakes that people make are (1) not investing i.e., procrastination or (2) doing too much i.e., turning over investments, changing their mind and so on.

Of course, not doing anything is an obviously bad thing as nothing comes from nothing. I wrote about this in March. But, sometimes reacting, changing, tinkering, selling, buying and so on can be equally as bad. The truth is that investing requires a lot of patience. The quote below from Warren Buffett’s business partner since 1975, Charlie Munger says it perfectly.

When it comes to investing, doing nothing is often sometimes the most intelligent thing to do.

Research demonstrates that buying and selling destroys wealth

There’s a commonly cited story about global fund manager, Fidelity conducting research into which investment accounts performed the best. It is said that it found that inactive accounts i.e., where the investor forgot that the account existed produced the best returns, on average.

A study that included 66,465 investors concluded that portfolio turnover (i.e. buying and selling stocks) is inversely related to returns. That is, higher turnover leads to lower (about 5.5% p.a.) returns, on average. Whilst this study only considered stocks, the same would be true for every other asset class.

Three reasons why you need the discipline to be patient

If you have the discipline to be patient, you will enjoy much better investment returns for three reasons.

Most investment markets move in cycles. That is, a period of above-average returns follows a period of below average-returns, as shown in this chart of historic property returns. If you were unlucky and invested at the beginning of a flat growth period, it’s likely that you must hold an asset for a much longer period to generate a return close to the long-term average (i.e., 7-8% p.a.).

For example, generally, you must be prepared to hold a property for at least 10 years to enjoy the long-term average return (i.e., 7-8% p.a.). However, if you invest at the beginning of a flat period, you’ll have to hold the property for 15 to 20 years. Returns should be similar in both cases (i.e., 7-8% p.a.). The difference is the distribution of returns over time. Investment-grade apartments are a good example of this – see here.

Compounding capital growth takes time. As this chart demonstrates, the projected growth (equity) in the first decade of ownership is $580k. But in the third decade is projected to be $2.7 million! That is the power of compounding returns. The two key ingredients are (1)