Monday, September 14, 2015

The One Thing Most Impacting Your Investing Returns

Don't be fooled. The thing most impacting your returns 
is not what you think.

Befitting my line of work, I get asked about investing all the time. What would I recommend in energy stocks right now? What do I think the Federal Reserve's rate rise will do to the markets? Do I currently own anything in China? What would I suggest to get a college-age person's portfolio started?

All great questions, worthy of research and discussion. But the answers to none of these will substantially improve an investor's returns over time. Rather, each addresses a specific situation, and therefore impacts only a small percentage of any investor's wealth, or a mere moment relative to one's total investing life. Such narrowly focused questions are important but offer little help when most investors have overlooked the really big issue.

What's the really big issue? Is it diversification across industries and nations? Is it risk tolerance? Stocks versus bonds/commodities/real estate/gold?

No, the big issue is emotional management. Nothing will sap investment returns, destroy wealth, and lay ruin to one's financial future like a lack of emotional management.

Of course, when I try to explain this to folks who are looking for a great tech stock tip or the best online brokerage, they scoff. They just want to get their per-trade costs down so they can stop worrying about overpaying commissions. (That shouldn't be a concern anyway, as your trading ought to be infrequent ... no more than a few trades per month.) They laugh at the idea that getting a handle on their emotions-- something they've already proved by putting away the ice cream unfinished or not hurling a coffee mug at their boneheaded boss or offering a defensive driving example to their teenagers-- could possibly relate to their investment returns.

But it can, and it will. Managing one's emotions around investing is complex, surprisingly sneaky and astonishingly difficult. Often an investor will not even realize he or she is behaving out of emotion, and will insist the numbers bear out one action or another-- when in fact the numbers are really just a confirmation bias, lending data to argue that which she's already decided to do. (For more on biases and blindsides, click here.)

By way of example: let's say you've owned stock in a particular small-cap company for 6 months. You bought with the idea it would slowly grow over the years, and over the coming decades that stock would become a cornerstone of your portfolio and thus your retirement. But instead the stock rises over 50% in the first several months of your ownership. Pleased but surprised, you do a little research and determine that while nothing intrinsic to the company has changed, it's growth is so great and so fast that it's now totally overpriced. You decide to sell while it's high, before bad news knocks it back down.

Completely rational, logical assumptions, thoughtful strategic planning. Well done. But emotionally driven and absolutely wrong.

This happened to me. The company was Starbucks, which I bought the day it went public in June 1992. By New Year's 1993 the price had nearly doubled. It was early in my investing career and I wasn't expecting that kind of ride, so I sold-- thrilled and proud of my astonishing foresight and speedy returns (which I promptly converted into a motorcycle. Ah, youth.) I then missed the next decade of Starbucks' massive growth.

There was nothing intrinsically different about the company I owned, or the competitive environment surrounding it. So why did I sell? Fear. Worry. Knee-jerk reaction to discomfort that the price moved so fast. But it was to be foundational to my (ultimate) retirement, and the company was doing fine. And even if my guess was correct and it was suddenly overpriced, that price would have drop some ... and all else equal, the stock would have started slowly climbing again, as I originally planned. There was far more value in the stock, and much higher demand for it in the market, than I had realized. I need not tell you how much I didn't profit.

Here's another example: you've owned a stock for a long time and have done well with it. It's again your intent to hold for a long term (which, of course, should always be your intent). But one day you read that leadership at your company has made a big move, altering the business plan by spinning off what you believe is an important contributor to the business, and they've rearranging prices so customers pay more. To you, the shareholder, it seems like an irrational and unnecessary change. Up to now you've been impressed by the company's executive team and you don't understand why they would now act so rashly. You realize you've lost faith in the managers of your business, so you decide to sell and reinvest your gains elsewhere.

Once again you've acted with thoughtful deliberation and considered decision-making. You're keeping tabs on the business you partly own and making your call based on detailed research and sound reasoning. But again, you're making the emotional decision.

Bad Idea Hall of Fame
This also is a true story, one I've mentioned here before. In the summer of 2011 Netflix CEO Reed Hastings announced they were splitting the company: Netflix for on-demand video streaming and Qwikster for DVDs-by-mail. Pricing would be broken out and raised-- at a time when many customers were effectively getting both services for the price of one. Analysts balked. Customers quit. The stock tanked.

But even the most brilliant leaders screw up, and I should have waited it out. I ought to have trusted the people I had previously admired to sort it out, instead of panicking and leaping to sell my shares. Once again I focused on the short term-- even though I had originally purchased Netflix with an idea that it would someday supplant Blockbuster (contrarian at the time!) as the default movie-rental service. By 2011 I had 20 years of stock investing under my belt ... and still I let my emotions in the moment control my actions.
When you read something unpleasant about a company you own, the right thing to do is usually nothing. 
Within a month, of course, Netflix backtracked and killed the Qwikster plan. Hastings issued a painful public mea culpa, appealing to both customers and shareholders to return. The stock stabilized. A few months after that, the company released its first in-house episodic drama series, House of Cards. And the stock has been on a tear upwards since, another staggering accumulation of wealth that I've missed out on.

Who will be the new CEO?
As I write this, Twitter stock has been battered to a price less than a dollar above the company's IPO start of $26, which is $19 less than where trading ended on IPO day-- a one-day gain of 42%. They've got 50% more active users today than at their IPO and revenues are rising. They're about to install a new CEO (possibly a founder) and tackle a bunch of usability issues which have been holding them back. Are you a buyer or a seller? By the same measure, GoPro's high-resolution action cameras have a market share 3x that of the nearest competitor and they are soon going to release their own camera drone to capitalize on the explosion in drone photography used for sports, real estate, forestry and wildlife research and so on. But GoPro stock has slid 30% recently due to investor concerns about rising competition and whether its tiny are a fad product. Buyer or seller?
GoPro's latest: the Hero 4 Session

Don't be fooled by the news, and don't trick yourself into ignoring the impact your emotions are having on your returns. Develop an ability to resist quick reactions. Learn to look further out into the future. Obviously, no one has a crystal ball. But you're reading this because you believe in choosing the right companies and holding them for a long, long time. Trust your research, ignore your impulse. The stock markets overall have been rising for nearly 230 years (for my favorite-ever chart, click here). The right thing to do when you read something awful about a company you own is usually nothing. Manage your emotions and you will do a helluva job managing your portfolio, even if you do still keep one eye on the Fed's rates. 

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