Having grown up with microwaves, faster and faster computers and the convenience of cell phones, I, like most, have come to expect quick results from my actions. Whether it’s a quick drive-thru meal or fast internet speed this obsession with immediate satisfaction is engrained in our culture. Unfortunately this is a death knell in the investment world. Patience truly is a virtue and something I continue to struggle with all the time. I understand patience and its benefits but putting it into practice in real life can be problematic. Fortunately, one area of life where I have learned to have patience is investing. If you take one little bit of wisdom from this book, it needs to be this one. Building significant wealth happens over time and requires a great deal of patience.
Every single day we are bombarded with news on the economy and the investing markets. We can receive investment news twenty-four hours a day and a multitude of opinions on what to do with our money. Remember this: building wealth is not a short term proposition. If you are going to be successful, you will need patience and persistence.
Rule of 72 and Your Investment
The Rule of 72 works like this: divide seventy-two by the annual rate of return (72/8=9). This determines how long it takes money to double at a particular rate of return or interest.
Recent research covering the past 30 years shows the stock market has returned approximately 8% per year compounded. Using the Rule of 72, that means your money will double every 9 years with a 8% compounded rate of return. This is the interesting part. Research shows the average investor over that same 30 years has earned only about 3% compounded. Rule of 72 math tells us it will take 24 years of compounding at 3% to double your money!! Yikes!! Why would the average investor only earn 3% versus what the markets did? The answer is surprisingly simple. The average investor got impatient and scared when the economy and markets took a dip. The average investor did not view a down market as an opportunity to purchase a greater number of shares at exceptional prices. The average investor allowed the talking heads on TV and mass media to influence their emotions and thus their investment strategy. The average investor got out of the market at the worst possible time, when prices were low. In addition, they didn’t get back into the market until it was significantly higher. It’s easy to fall into this trap.
The Crash of 2008
Let me refer to recent history and review 2008 (some refer to it as ‘the crash of ’08’) as an example of poor investor behavior. The real estate market became severely overpriced because of low interest rates and relaxed borrowing standards. Lending institutions were giving out loans to just about anyone to buy homes, cars, boats, etc. Many of these borrowers simply could not afford to pay their loans (and never should have qualified for them in the first place) and it began a vicious cycle which eventually impacted all of us. In a matter of two months, the stock market fell over 50% in value as real estate prices plummeted.
The easy and emotional reaction was to get scared (impatient but mostly scared) and sell out of their investments related to the stock market. The market ‘felt’ way too risky and the average investor sold out at ‘garage sale prices.’ This not only locked in their loss but also took them out of the market. When I say ‘locked in’ I mean when you sell your investments at whatever the current price is to you ‘lock in’ that price. If the price is low that’s what you get. If you invested $1,000 and that investment is now worth $500 when you sell you have ‘locked in’ a loss of $500. An investor who sells out has to be right on two decisions – when to sell and when to buy back in. I would say most of the time you will get one of these decisions wrong.
You really haven’t lost anything until you have sold. It’s all on paper. Given a young person’s long investment horizon why would you sell in the short term? There is no good reason. Why take the chance? Learn to be patient and take positive actions. Positive action could include actually adding to your investments when the prices are down. Psychologically this is very difficult because it will ‘feel’ like the absolute worst thing to do. Force yourself – have faith in the future and learn to do what others are not. This is the pathway to great wealth.
When you see events like this happen, and they will, you need to train yourself, not only to be patient, but to take advantage of the ‘50% off sale’. If a desired cell phone went on sale for 50% off wouldn’t you consider buying one? You should have the same approach when investing in the markets.
There are times when fear and gloom overtake the national psyche and it’s easy to get sucked into that mentality. However, if you truly want to build wealth, these situations create incredible opportunities. Imagine buying stock in companies like NIKE, Pepsi or Google at 50% off prices. Professional money managers have learned to divorce themselves from the fear emotion and do some ‘bargain hunting’ in down markets. If you saw an item that was grossly underpriced at a garage sale wouldn’t you seriously consider the purchase because it was such a good value? The truly successful investor increases their investments when the markets are down. Sometimes those markets are down for two or three years. We may feel stupid because we’re not making any money . . . yet. But, when everyone loves the stock market again you will have positioned yourself advantageously because you have consistently bought shares at excellent prices during the down periods. Good values are always worthwhile if you’re patient.
It is 2013 as I write this. From March 2009 to November of 2013 the stock market is up approximately 136%. Those who panicked and sold out missed out on this significant return. Those who stayed the course, increased their investments when prices were low, have regained their value plus some. Patience is a virtue worth learning with investing. Whenever you are tempted to drastically change your course make sure you determine whether it’s fear or logic supporting your rationale.
Making choices based on the emotion of fear rarely results in a positive outcome.
Fear is often in opposition to patience. The typical investor’s greatest fear is losing money. It’s nice to have money but mon ey brings its own challenges and demons to confront. Think about when you have felt fearful and what kinds of thoughts run through your mind. You might think of dire consequences, consider harmful outcomes or have an inability to take action.
In the stock market you can determine your share values on any given day. If you own real estate it’s more difficult to determine value as it’s truly worth what someone else would pay. This obsession with daily pricing can cause many people to make awful decisions. As we listen to the negative news it’s difficult to hear the voices that make one feel confident and courageous. It’s hard to invest when you feel this way. You become paralyzed (a sure signal you’re reacting out of fear). The fear emotion tells you to flee, to get out now yet that response works directly against your long term investment strategy. Again let’s use the ‘Crash of 2008’ as an example.
Your best friend had $100,000 invested in the stock market when the markets tanked and lost 50% of its value. They allowedfear to rule their mind and sold out at this level. Now they have $50,000 in locked in losses. They invest the money in a money market account paying 0.1% (that’s right less than 1% return). They have calmed their fears by placing their money in an ultraconservative, ‘safe’ investment. The markets thrash around for about five months and in March of 2009 reach a crescendo of pessimistic news. The news made one feel like all the banks were going to fail, there would be massive unemployment, and most of us won’t be able to pay our mortgages, etc.
You, on the other hand, remember that when the markets go way down it creates opportunities. Other’s fear is actually your new best friend. You cautiously add money monthly and in March as you ‘see’ the fear reaching a peak you invest a bit more. You have successfully bought additional shares at garage sale prices. From March 2009 to February 2010 the market goes up 70%. Let’s see how everyone did:
Your Best Friend - $50,000 * 0.1% = $50,005
Patient Investor - $50,000 * 70% = $85,000
Granted you are not back to your original $100,000 but you are well on the way to recovery. By the way, did you really lose that money if you never sold out of the market? Your spreadsheet or Quicken account took a beating but in the real world what did you lose?
Your best friend beats himself up for being ruled by fear and vows to get back in but remains fearful the market will come back down. He reinvests after the market makes a meaningful move up, a pattern typical of scared investors. The result? He gets the ‘benefit’ of buying shares at higher prices with less money to invest because of his locked in losses. Let patience, not fear, rule your decision making. Simply put, make your money work over the long term.
Diligence is nothing more than becoming responsible for your financial life. It’s a willingness to learn what you don’t know and to seek help if you need it. Diligence translates into specific financial goals which then drive the investment decisions you make. Once you develop a system that works for you it’s a matter of adapting as life changes. Be diligent in sticking to your long term plan. With a good system in place you take a lot of the worry about money out of the life equation so you can concentrate on your true passions in life.
There are several ways to make your journey through the financial maze more pleasant. First, know this; all investments have risk of loss. Still, most do not create a TOTAL loss. Win or lose propositions are not good investments. Your likelihood of success with these types of investments is similar to playing the slot machines. Trusting your investment to speculation and chance are risky at best and downright foolish at worst. I’ve seen so many people blow up their life because they speculated and lost. My advice. . .stay away from win or lose propositions.
I like to think of risk as volatility in prices. In other words, most every investment fluctuates in value every day. This volatility in price is what causes us to consider selling at the wrong times and plays into the fear emotion. As a knowledgeable investor you can protect yourself in several ways. I want to make clear these ideas do not cure short term panics such as we saw in 2008 but, if you adhere to them, you’ll recover and thrive sooner.
1. Have your emergency fund in place. One of the main advantages of this is you do not have to sell investments prematurely to cover any unexpected expenses thus avoiding potential capital loss in your portfolio.
2. When you invest be as diversified as possible. Diversification smoothes out market volatility. Mutual funds, in general, are very diversified. In a growth mutual fund the dollars might be invested in over 200 companies within that mutual fund portfolio. As a shareholder you own just a small percentage of that mutual fund and an even smaller share of any one company. The risk of 200 companies all performing poorly is much less than the risk of any single company performing poorly. To be properly diversified you’ll probably want to seek some basic asset allocation counsel. This can be a local Financial Advisor or someone within Human Resources at your place of employment. You might pay a little for this service but it would be well worth your while.
Asset allocation allows you to place money into several different investment areas appropriate to your life situation. For example you might have a growth mutual fund, an international mutual fund and a bond mutual fund. As a young person you might consider an allocation of 80/20. This means 80% in growth ivestments, 20% in conservative investments. In my example above the bond fund would be the conservative investment. Asset allocation strategies change over time particularly as one gets older. This is where the advice of a trusted advisor or professional can be invaluable.
3. Invest for the long term and attempt to invest more when the markets are down.
4. Add money regularly, preferably at least monthly. If you can participate in a company retirement plan this is a great way to build wealth. You can ask your company to withdraw a certain dollar amount each pay period to invest within the plan. You can also have investments outside of retirement as well. Investing on a set schedule, making investing part of your financial routine, takes the emotion out of participating in the market. Down markets are a gift to you only IF you take advantage of them.
5. Continually educate yourself. The world of finance is really quite interesting but you don’t have to be a genius to be a good investor. Take some classes at the local community college and look for other educational opportunities. There are a wealth of educational opportunities online. As you become more comfortable investing you will be more confident in following an independent path to creating your own wealth and also wise enough to capture opportunities as they present themselves.
6. Hire a Trusted Advisor. This will sound self serving but I really do think most people would benefit from having an honest and intelligent Financial Advisor. A Financial Advisor is especially helpful when the markets turn sour and you need to talk with someone who has greater depth of knowledge on the subject. A Financial Advisor can help you develop a plan, monitor the plan on a regular basis and help calm you when the world seems like it’s falling apart. Lastly, they can develop an appropriate asset allocation model for you to accomplish your goals which include specific strategies and investments.
7. Talk with your parents or get a couple of referrals from them on an older person with whom to talk. Perhaps you might speak with their Financial Advisor. Experience is a great teacher. Most adults would be honored to share their wisdom and their mistakes. Developing a conversational relationship with these experienced and knowledgeable people is invaluable when building the foundation of your financial future.