99% of Long Term Investing is Doing Nothing
It’s a bold headline to be sure, and perhaps exaggerated, though not by much. This is also not an original view, but it helps to be reminded of it from time to time. The recent government shutdown and debt ceiling farce (er, I mean, crisis) have reminded me of it. During the last month or so of our National Lampoon’s Rationality Vacation, I have bought and sold zero stocks, aside from my automated monthly DRIP purchases, 401k contributions, and 529 plan contributions to index ETFs for my two children. I am happy about that.
So what is the work actually involved in long term investing? For my own purposes I break it down into the following four categories.
- Either purchasing index funds or selecting a relatively small portfolio of stocks (no more than 25), focusing on stocks that you both: a) believe are presently undervalued; and b) have a reasonable likelihood of growing earnings and cash flow faster and more consistently in the long-term than the universe of stocks as a whole; which c) preferably but not necessarily pay a dividend that has been historically increased with boring regularity.
- Generally reviewing those stocks (assuming you buy stocks, not index funds) about once per year (or even less often) to make sure your buying thesis is not totally blown. (I.e., you want to make sure you have bought Coke in 2009, not Blackberry in 2012.)
- Rebalancing your index fund investments once per year at a set time each year, which can be automated.
- Being generally aware of market conditions, but only insofar as the aggregate value of stocks is either far below or far above historical averages. With the understanding that you may do absolutely nothing based on this awareness.
A few words on each category:
The most important is Category One. If you succeed in purchasing companies that meet those two criteria (and the third preferable criteria), you basically never need to sell them. Go to the beach, play with your kids, do your job, be affectionate to your spouse, and take care of your health. When people talk about “evaluating free cash flow,” that is valuing the company now. When people talk about “moats” or “competitive advantage” or “return on equity” or “return on capital” or “brand,” or “patent protection,” those are all ways of evaluating whether the company is reasonably likely to grow faster than the universe of stocks over the long term, or at least whether it is likely to be sufficiently successful that you will not lose your money. This means don’t buy “turnaround” stocks like J.C. Penney or Blackberry these days. Too much risk that you will have to do lots of Category Two work, even if you are correct that they aren’t toast. I have owned a bunch of Phillip Morris stock since 1998, before the SAB Miller partial sale, before the Kraft split, before it split into two companies, Altria and Phillips Morris International. I have had wild gains in this stock, always reinvesting dividends, during one of the great secular bear markets. I sold the Kraft when that split off and reinvested it in Phillip Morris. I eventually sold the Altria after that split, and reinvested it in Phillip Morris International. I very well may never sell this stock. I only seriously even think about it about once every two years or when something happens in regard to it that is significant enough that it appears in the business section of a generalist newspaper. I seriously think about this stock about an hour per year. That, to me, is investing success.
Category Two could also be titled, “Don’t Be An Ostrich.” Technical traders look stupid when the change their minds by not sticking to a previous stop. If they violate their preset short-term buying and selling rules, they will eventually blow up. They are psychologically disassembling and turning into gut-motivated day-traders. Long term investors look stupid when they don’t change their minds or ever consider selling. If they never sell anything or even look at it, they will eventually blow up, too, at least in one or more positions. They have turned into ostriches. There is no such thing as “buy-and-forget.” If you really want to be a “buy-and-forget” investor, start buying index funds when you get your first job, and other than yearly rebalancing, set a timer to start thinking about them again when you are about 60. But if you must buy stocks, you do have to think about them occasionally, even if you think they are great companies. I aim for once per year. When I bought Phillip Morris in 1998, I also bought a much smaller amount of Eastman Kodak stock, literally only about $200 worth. (I was in college.) I totally ignored it and rode that $200 to zero. I didn’t need to gather news on Eastman Kodak daily to avoid that loss. I just needed to analyze it at least once within the first five years or so after I bought it. Unfortunately by that time I was out of college, making lots of money, busy with my wife and friends, and it was only $200 and I just did not care. Still, lesson learned.
Category Three only applies if you are buying index funds. Studies as far as I know show that rebalancing your index funds to their original percentages is beneficial to long term returns. This is because reversion-to-mean is a fact of life. It’s the investing equivalent of taxes and death.
Category Four is optional, and probably should be excluded by the vast, vast majority of people. But it’s important to talk about it, if only so you know why you should ignore it. You can get into trouble here. It’s also extra work. I hate extra work. If you are a fearful sort, there is always a reason to be all cash. If you an aggressive sort, there is always a reason be all in stocks. Know thyself. Here you have your biggest risk of massive psychological error, because decisions made in this category can impact your entire portfolio, not just one stock purchase or sale. Here is where you buy tons of Janus mutual funds in 1999, and where you panic-sell everything in March 2009. But here you can also have our highest possible impact. Here is where you either stop buying stocks in 2000, or you go all-in in 2009.
Notice I didn’t say “sell” stocks in 2000. If you have satisfied Categories One and Two, and particularly if you have been holding them for awhile (thus building psychological capital), you don’t really ever need to sell stocks, even at market peaks. You’ll survive the inevitable drop, you’ll have the fortitude not to panic-sell at the low, and you’ll benefit from the eventual rebound. Timing is hard. I think at a market high it’s generally best to simply chill out, maybe sell stocks if any that you bought on a flier or based solely on temporary undervaluation without much faith in the long term business (already a mistaken purchase), and build cash for the drop. If you sell, you are likely to sell way too early, then freak out when stocks rise, then buy way more at the top and consequently lose more, and then panic-sell after the drop because you hate yourself for buying back in so strongly at the true top. Then you are well and truly screwed, my friend. And even if you correctly sell at the top, you’re quite likely to buy back in way too late, after a sharp rise off the bottom. Satisfying Categories One and Two and riding the thing out is, in my view, the best way to preserve psychological capital. Satisfy your market-timing urges by reducing new purchases as you begin to perceive a market-related topping. Build cash. Pay down debts. Go to Disneyland.
If that all sounds like a lot work still, that’s because it is. It’s work, even if you only look at your stocks once per year. It’s work picking them in the first place. The true zen master probably just buys index funds and rebalances them for forty years.
My continuing fascination with common stocks as a non-professional with a full-time job probably is indicative of my egotism, and some cognitive bias. But I have done well enough, beating the S&P though only marginally across all of my accounts, not making huge mistakes, that I continue. Still it’s quite possible I’ll write a post one of these days throwing up my hands and saying I’m all in index funds.
Anything you do beyond these four categories is not investing, it is indulging in a hobby. Reading financial blogs all of the time, following finance people on Twitter, writing this blog: a lot of the things I do I do mainly for fun. Whether you are an long term investor or a trader, this is all perfectly fine, as long as you recognize it is totally separate from your actual investing/trading process, and as long as it doesn’t lead you to violate your rules.
Stay frosty out there.