27 Jun Investing is not rocket science
Image from NASA Imagery via Pixabay
There can’t be many professional investors whose name is familiar to a large number of people around the world. Perhaps the one whose name is cited most frequently is Warren Buffett, ‘The sage of Omaha’. Buffett’s early investing career as a stockbroker led to him starting several investment partnerships and subsequently to investing directly in businesses, one of which, a textile manufacturer called Berkshire Hathaway, of which he took control in 1965 before transforming it into an investment vehicle. In 1965 a single share cost $7.50 – as of April 2019, it was close to $119,000 – an annual compound return averaging around 19%.
Yet his views on how investors should think about their assets are much less about what the Federal Reserve, or the President, or China will do next than might be expected. Instead, he told a tale about a farm that he had owned for several decades. He did not lie awake at night fretting about its market value and how that fluctuates from day to day based on other people’s perceptions of the attractiveness of agricultural land and the prospects for crop and livestock prices. Instead he focused his attention on its long term value and its ability to generate cashflow year after year. While most investors will not own a farm, they do often own a home and their approach to that is normally much the same – unless you want to move, the price of your home is of very little importance to your life.
However, the opportunity to identify the monetary value of your home arises fairly infrequently as it depends on the occasional transaction in nearby properties of similar size and specification. Even then, the price of an individual transaction can be influenced by specific factors such as a desperate seller or buyer so it may not reflect the wider market. Obviously it is possible to have an estimate from a valuer but they are only making an educated guess anyway and there can be a world of difference between the estimate and what an actual buyer pays. In addition, not all valuers are unconflicted (they may be hoping to act for you in selling the property, so suggesting a value at the upper end of a range might be expected to increase their chances of earning more fees).
With listed stockmarket investments, however, assets are priced by the day or even the second as transactions are happening continuously. For someone used to seeing prices once every few years, suddenly being exposed to them on a daily basis can be a shock. Instead of being seen as a beneficial aspect, the continuous liquidity and visibility of prices becomes a curse.
Consider the two investments represented by the charts below. An investor in Asset A has clearly experienced a fairly exciting ride whereas the owner of Asset B has had a much smoother experience with far fewer price fluctuations. For an investor nervous about sudden movements in portfolio value, Asset B looks much more appealing.
The thing is, they are both exactly the same investment (as it happens, the MSCI World Index from 1970 to 2010 although the same principle applies to any asset). Asset A shows the index value on a monthly basis while Asset B shows it once every 10 years. The points on the 10-yearly chart therefore match exactly the index values for those months on the monthly chart. An investor who held Asset A throughout the period would have exactly the same return as one who held Asset B and, inevitably, the same amount of price fluctuation. The sole difference is the visibility of those fluctuations. However, looking at the value every month rather than every 10 years would likely have resulted in a rather different perception for the investor of the degree of risk that they were taking.
While Buffett has undeniably been successful in identifying companies in which to invest, the sage himself advocates most investors doing the opposite. “The goal of the non-professional should not be to pick winners”, he said in one annual newsletter for Berkshire Hathaway, the investment vehicle he uses. “The ‘know nothing’ investor who both diversifies and keeps his costs minimal is virtually certain to get satisfactory results”.
There will always be a range of opinions as to the future direction of interest rates, trade policy, currency movements and hundreds of other economic and political factors which influence how investors behave. The news media and indeed just about anyone we meet or speak to may have an opinion. However, we are under no obligation either to listen to them or worse, to act based on those opinions.
Investing, whatever the talking heads in the media might wish us to believe, does not require a huge intellect for success. Unlike in many fields of human endeavour, smart people do not necessarily beat the rest. After all, the financial institutions which failed so spectacularly in the global financial crisis in the last decade all employed bright people with postgraduate qualifications in relevant disciplines and they didn’t manage to avoid disaster.
As Buffett says, “You don’t need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ.”