Be patient and you will prosper

THE path to investment success is fraught with peril. It needn’t be this way.

THE path to investment success is fraught with peril. It needn’t be this way, but along the road there are many traps for the unwary, and it seems that the natural state for we humans - at least when it comes to investments - is a certain level of unwariness. With this in mind, I’ve set out below what I see as some of the main pitfalls along the way, and some thoughts on how you might avoid them.

Pitfall 1: Not knowing the long-term objective.

Any investment strategy should be built on a solid foundation of knowing what the strategy is meant to achieve. It’s hard to steer the ship if you don’t know your destination, and the critical element here is being realistic. Investing can certainly make you wealthy slowly, but it is far less likely to make you get rich quick. If your objective is the former (and it probably should be), you should act accordingly.

Investors who lose sight of this are prone to take on too much risk trying to turbocharge their short-term returns. This can manifest in excessive leverage, placing big bets on companies of dubious quality and trading too frequently. On the other hand, a clear view of what you are trying to achieve (and when) can give you the patience to avoid temptation.

A reasonable expectation from the equity market is a long-term average return of about 11 per cent a year. Over long stretches of time, this is enough to achieve meaningful wealth accumulation, and if you can do a bit better than this through wise investment selection then so much the better. However, if you neglect the long game and instead try to hit the ball out of the park today, there is a good chance the long-run outcome will suffer.

Pitfall 2: Allowing emotion to take over.

Q: What do most share investors feel when the stockmarket has risen strongly? A: Happy!

Q: What should they feel? A: Concerned.

It is a well-established fact that we typically form our views on the stockmarket with one eye in the rear-view mirror. This is understandable, as the windscreen can be very cloudy. Research has shown that investors consistently pour money into the equity market when it has been rising, and take money out after it has fallen. The same research shows that this behaviour is devastating to long-term returns because it means investors get the timing wrong. Like clockwork. If you have successfully negotiated Pitfall 1 and are taking a patient approach to wealth creation, it will be easier to deal with Pitfall 2. Taking a long-term view means not worrying about what return you got last year - or might get next year - but taking steps to ensure a good result on average over the long haul.

We have a client in our funds management business who takes no interest in monthly investment updates. Instead, he has satisfied himself that what we are doing is sensible and, having made the decision to invest, now plans to check back with us in 10 years.

There are no guarantees in this game, but this type of approach is as close as you can get to a guaranteed good outcome. On the other hand, we had another client who recently invested with us, and then two months later withdrew the money because the results in the intervening two months had fallen short of the index. We can’t do much to help this client; we doubt any fund manager can.

Pitfall 3: Forgetting risk.

Risk management is the forgotten, frumpy cousin of investment. It deserves more attention.

In the short term, taking on risk can lead to better investment returns, but in the long run risk is risk and sooner or later its downside emerges.

Astute readers may have noticed that the three pitfalls I’ve identified are all sides of the one (oddly shaped) coin: patience.

Many years of observing investor behaviour has made one thing very clear. There will be twists and turns from year to year, but in the long run the equity market takes wealth from impatient investors and delivers it to patient investors. Those who sell shares at discounted prices in the midst of a crisis are planting the seeds of future wealth for those willing to wait for it, and those who chase spectacular returns may succeed for a time, but sooner or later most will get caught.

Patience is boring and does not make for racy investment stories, but if your goal is long-term wealth accumulation there’s probably nothing that will get you there faster.

Roger Montgomery is the founder of Montgomery Investment Management.