At Morningstar, we study how people make financial decisions and the obstacles they face in making effective choices. Through our behavioural finance research, our goal is to better understand investors – who they are, what it means for them to succeed, and how we can guide them along the way. We then apply these insights to help investors reach their financial goals.
The great investor, Warren Buffett said that “few aspects of human existence are more emotion- laden than our relationship to money”. When it comes to your financial health and wellbeing, we can’t stop our emotions, but we can help ourselves manage the impact of our emotions and the resultant impact on our finances.
During market volatility, emotions become heightened, often leading to investors making knee- jerk decisions that cost them dearly. In times of market turmoil and panic, the best thing to do is often to sit tight and do nothing at all. This has been easier said than done, given the Covid-19 related market volatility we have been facing since early 2020.
While not much has changed and we continue to live in this new Covid-controlled world, we have seen markets rally almost 70% from the lows experienced in March 2020. Amid the terrible lows and subsequent highs, an interesting trend seems to have emerged – investor’s initial fear has started to turn into excitement and exuberance about markets.
We are seeing some areas of the market quoting double and/or even triple digit returns. We hear of friends or colleagues that have made enormous amounts of money by being invested in Bitcoin. We’re witnessing many investors shaking their heads in disappointment – why did I not invest more money in Tesla? Why didn’t I take more risk? Why do my investments look so boring in comparison? It is a thought I’ve grappled with myself.
As fate would have it, I recently finished reading Morgan Housel’s book, The Psychology of Money (a highly recommended read) and in one of the chapters, he focuses on the concept of “getting rich” versus “building wealth”. In this chapter, he unpacks the theory that, while everyone believes that they want to be a millionaire, what they really want is to be able to spend a million rand. But to spend a million rand, you need to have acquired wealth well in excess of that. Unless you have a miraculous get-rich-quick strategy, wealth is generally built over a long period of time.
There are many great examples of investors that have acquired wealth over time, but one of the best success stories, in my opinion, is that of the aforementioned Warren Buffett. Even after giving away 99% of his wealth, Warren Buffett remains the fourth wealthiest man in the world according to Forbes.
While there is no dispute that Buffett is a skilled investor, few people know that he accumulated 96%1 of his wealth after the age of 65. The secret to his wealth and success – slow and steady wins the race – he gave his investments the needed time to compound and grow. Starting at the age of 30, his investments had a 40-year time horizon. He grew his wealth slowly. Looking at his approach, it seems so obvious and one can’t help but think that he must be both brilliant and a little bit lucky, but in fact, time and patience was his greatest contribution to his wealth creation.
How times and investment philosophies have changed. We live in a world where instant gratification is the order of the day and patience is a nuisance practised by few.
Unfortunately, the stories of individuals starting a ‘tech company’ and selling it for billions, are the exception, and not the rule. Going from zero to zillionaire isn’t the order of the day and the reality is that, for most of us, we need to build our wealth over time, through diligently saving and investing our hard-earned money.
As boring and uninspiring as that may sound, there is something fabulous about it too. Regardless of how much you invest, if you just have the patience to let your investment compound and the discipline to continue saving through good, bad and boring times and to not get distracted, you will be amazed by the power of compounding over time. It is in fact, the eighth wonder of the modern world. In a way, it is the factor that levels the playing field for those that don’t make millions with a tech start-up overnight. It is okay to grow your wealth slowly.
Here are a few tips that may help with the process:
1) Automate the savings process and make it difficult to stop.
Have a fixed debit order with a set amount that comes off your account as soon as your money comes in. Pay yourself first but don’t think of savings as an expense, because there is always a reason not to save. Think of your “spendable” income as the amount you have left after your savings amount has already been subtracted and it will feel less painful.
2) Look at your investment less frequently (as counterintuitive as this may seem).
In the short term, markets can be irrational and price moves do not always make sense. Remind yourself that your equity investment is an ownership stake in a solid business. You shouldn’t worry what the market does in the short run, but rather remain focused on what companies and businesses you own and give them time to grow your money.
3) Don’t worry about your friend’s hot tip.
Someone will always believe they have the latest hot tip and will likely be eager to share it but as mentioned earlier, let your money grow in the right way. If you feel the need to invest in a “hot tip” investment, rather do so with additional savings and with an amount you won’t be too sorry to lose. Don’t withdraw from your current investments and interrupt the process of growth and compounding that you have set up.
4) Your investment is not meant to be exciting.
Once you have made peace with the fact that your investment is going to take 20-30 years to build, it is actually very boring in-between. Let it be boring, that is when the good stuff is happening.
5) Know yourself.
Learn to understand your reactions to the following example scenarios: market crashes, hot tips, panic about bad political news, worry about our country, “FOMO” about not owning US tech stocks, etc. Once you have an internal checklist of how you react to these events, write down what advice you would give to yourself. If you are not sure what to say, the best advice I can give is to not take your reaction out on your savings and investments. Leave them out of it. Let them be.
In Conclusion
Over decades of evidence and through the investment literature there is one golden thread – time in the market remains superior to timing the market.
Ask yourself this: “Given where I am now, what actions move me closer to my long-term goals?” “Would an investment change align with the original investment plan for reaching well-defined goals?” These are different questions than, “What do I wish I had done last month?”.
We believe that investing is a long-term pursuit, patiently allocating to assets that will help you achieve your goal. So, if you catch yourself getting down about the state of the equity market, trying to predict what’s next, or getting bored with your investments, always remember why you are investing in the first place.