It’s 4 in the morning and work starts at 7, the alarm goes off but instead of the annoying buzzing sound, it’s soothing classical music that only a methodical human being could wake up to. The methodical person grabs their outfit (which was already laid out the previous night) and gets dressed without a worry in the world. Teeth brushed? Check. Briefcase? Check. Everything is in order for this magnificent human being. Getting on the freeway she sees the speed limit is 65, she goes 63 because there is no rush, she’s going to be 20 minutes early if she went 50. You might relate to this person (must be nice), or you might be like me where you are running out the door as you are brushing your teeth. If you relate to the former person you like to plan for the future, every aspect of your life is probably under control and you start things way in advance. This person does not mind sitting in traffic because they left extremely early and they are going to get to where they are going in time with or without traffic. Contrary to the “Traffic Weaver” who will leave at the last minute and jump in and out of traffic, this person does not have a care in the world, they understand that safety comes first and just being a responsible human being will do the job. Meet The Lane Sitter.
Case #2: The Lane Sitter
There is an investing rule called the rule of 72. Basically, any compounded rate of return you achieve can be divided into 72 and the number that pops out is how many years it will take you to double your money. The Lane Sitter knows that historically the stock market has returned an average of about 7% per year after inflation which means that it would only take around 10 years to double her initial investment. Therefore, if she made an initial $10,000 investment at 20 years old, she would have $20,000 by 30, and $160,000 by 60 years old, adjusted for inflation of course! This is similar to a person who takes off before rush hour even though it means waking up earlier. There is the opportunity cost of having to wake up 30 minutes earlier every morning. The same way there is an opportunity cost to invest your money for the future rather than spending it now. If you are as good of a person as I am (which is impossible) then it’s tough to decide between investing your money (essentially delaying your satisfaction) or giving it all to the homeless right now (making you happy and fulfilled now), in turn making you homeless. These are the tough decisions that need to be made and are made on a daily basis whether they are conscious or not. The person that makes the sacrifice (delayed gratification) and wakes up early will receive a greater benefit of not having to spend an extra hour sitting in traffic. The cost is 30 minutes of sleep, the return is an hour less of traffic and not having to stress about getting to work on time.
There is also a psychological aspect that comes along with trading your hard earned money in the financial markets. In a recent study conducted by Joseph Engelberg and Christopher Parsons out of the University of San Diego, the increases in hospital visits for psychological reasons after a market drop were measured from the years 1983 to 2011. Their findings are quite astonishing, “The results of this analysis indicate at least $100 million in additional, annual hospital-related expenses for Californians, though again, the true effect is undoubtedly larger” (Engelberg, Parsons, 2016). This analysis shows that when the markets turn against people who are relying on their investments to pan out within a shorter time period it can put a mental and emotional beating on them. This is unfortunate because it can be avoided.
The greatest value investor of all time, Warren Buffett, has made a career of analyzing a company’s fundamentals and he firmly believes that the price of securities do not matter. You might be saying at this point, “Can you stop being selfish please explain value investing so I don’t have to Google it.” Fine, have it your way. The idea behind value investing is buying relatively underpriced securities that are intrinsically more valuable than their current price is reflecting. After the security is bought it is then held until the price converges to a fair value. A good value investor understands that if the security is bought when the fundamentals say the company is undervalued then it does not matter what happens to the price in between buying and selling the security. The only aspect of time that matters to a great value investor is when the fundamentals say to buy and when the fundamental say to sell. You might be saying this is a ridiculous concept, “How could millions of investors be wrong about the price of something that’s traded constantly.” Interesting point, you are always keeping me on my toes. I could ask you how could thousands of drivers tailgate and consistently merge incorrectly when they are constantly driving, but an analogous question is not the answer you are looking for. The answer to your brilliant question is intertwined in everything we have been talking about. Investors are emotional and have different expertise levels which can lead to mispriced securities. In other words, no matter what your textbook says about assuming all people are rational and how they always make optimal decisions, they don’t. People act irrationally within the financial markets, people act irrationally when driving, people jump in zoo enclosures and get gorillas shot for no reason! R.I.P. Harambe.
Even though Harambe never had the time to find his inner trader (I don’t get over things quickly), you still have the time! If leaving the house early to beat traffic sounds lovely and sitting in one lane on the freeway during traffic sounds logical then you might be an emotional fit for a value investor. The reasoning is because of your ability to plan for the future and the perspective to see that the risk of constantly switching lanes to get a small advantage is not worth the reward of potentially getting a little bit ahead. Value investors have some attractive advantages over day traders. Buy-and-hold investors get to pay the capital gains tax rate, which can be significantly lower than the regular income rate when they hold a security for more than a year. They also have much lower trading costs than day traders simply because they are trading way less. When someone is trading over 100 times in a day a $10 trading cost will add up quickly. Most of all, if they are doing the proper fundamental analysis they will be able to clearly justify to themselves why they are holding a certain security through the tough times, which will relieve some of the psychological distress of the market turning against them.
Investing doesn’t have to be a painful nerve-racking task, it can be an exciting journey with new mysteries about the world uncovered each trading day. It can even be a spiritual journey, a process in which you can find yourself and learn more about how you react to different exciting and stressful situations. Most important of all, understanding who you are and mastering what works for you will ultimately make you a successful investor because you will be able to stay true to yourself. If you feel as if value investing fits your personality, learn the ins and outs of it and master it. People have gotten rich from day trading and through the proper use of value investing, it really does not matter too much which you pick. The only thing that matters is you understand yourself; if you can’t conceive how its possible to go 10 mph in traffic that’s going 5 mph, become the next Warren Buffett.
Engelberg, Joseph, and Christopher A. Parsons. “Worrying about the Stock Market: Evidence from Hospital Admissions.” The Journal of Finance 71.3 (2016): 1227-250. Web.