Successful Investing Requires Coping With Some Discomfort

As Chair of the Troy SIG group for the AAII, I was required to join this national organization and so now have access to a wealth of investment information from them too.  So here is the latest from the AAII, an essay on the one characteristic that all investors must have to be successful, which is the ability to endure some short-term discomfort for the sake of long-term gain and how to acquire this ability.  It's not a long read and one that is on a topic that is near and dear to all of us.

Of course, we are dedicated to managing risk through FastTrack strategies that choose high-growth low volatility funds and stocks.  It seems to me that discomfort is the result of volatility.  Thus it may be the greatest selling point of our MRI/FT group that, using FT, we might eliminate this short-term discomfort. Anyway, that is the goal, that is why we are studying it.  Meanwhile, this article provides another valuable perspective.  Enjoy the read and enjoy what's left of this very comfortable weekend.


AAII Investor Update

Successful Investing Requires Coping With Some Discomfort 
Thursday, August 3, 2017

“Super investors take pain better than everybody else.”

Wesley Gray, CEO and CIO of Alpha Architect, made this observation at last week’s Financial Analysts Seminar, an annual CFA Institute event hosted with CFA Society Chicago. He was referencing the ability of successful investors to stick with a strategy.  

Gray raised the point as part of a discussion about factor investing. Factor investing is selecting investments based on certain quantitative characteristics such as a low valuation (value), higher relative returns (momentum) or a smaller market capitalization (size). He could have easily made a comment about any other investment strategy.

Pain in the world of investing is incurring a loss. It can be a drawdown, a drop in the value of your portfolio. It can also be the loss of upside returns. Even if your investment is appreciating in price, the perceived loss of not being in a better-performing investment can be discomforting. Either way, loss is a powerful driver of human emotions and decision-making. Psychologist Daniel Kahneman says the pain of a loss exceeds the pleasure of a gain by a measure of 2:1.

Pain is also very personal. A strategy one person finds easy to follow can be extremely difficult for another person to adhere to. Similarly, the pain threshold at which one investor panics or otherwise abandons a strategy can be different for another investor. Gray said he knows of one person who has been able to withstand “multiple” drawdowns of up to 75%. (This energy investor has accumulated significant wealth by sticking to a disciplined strategy over the long term. You can ask Gray about it at our forthcoming Investor Conference.) Other investors begin to get very worried when the stock market falls by 10%—not an uncommon occurrence. (In their defense, I have yet to experience a market correction without strategists and pundits warning about it being the start of the next recession and/or bear market. Whenever Mr. Market’s mood turns sour, Chicken Little warms up his voice.)

As much as nobody likes discomfort (including myself), investors are rewarded for enduring it. If there was no discomfort, there wouldn’t be as much of a reward for investing.

There are things you can do to better cope with the discomfort of down or otherwise unfavorable market conditions. One is to simply look less often at the market and your portfolio. The longer you ignore the stock market, the less volatile it will seem. Another is to realize the advantage of being a long-term investor. Gray believes “patience” is very much an investor’s “alpha.” (Alpha is outperformance attributable to an investor or money manager.) A third thing is to be very focused on your process. Michael Falk, a partner with Focus Consulting Group, told attendees at a different session that process is six times more important than analysis in terms of realizing higher returns. (Good analysis is still required, though.) Part of a good process is having pre-established sell rules—not just for when things go right, but also for when things go wrong. He also advocates for creating a personal behavioral checklist. If you can determine what influenced your decision at the time you made a buy or sell decision, you can start to create safeguards and systems to help prevent repeating the same behavioral mistakes in the future.