First published in the Daily Maverick 168 weekly newspaper.
For years, financial advisers and institutions have been chasing the sums in their bid to earn their clients the most money possible. However, in the last 15 years, behavioural finance experts have weighed in with the news that your attitudes towards money and your behaviour have a huge effect on your investment portfolio.
Morgan Housel, partner at Collaborative Fund and the author of The Psychology of Money, shared these key behavioural finance insights at the recent Allan Gray Investment Summit.
Timing is meaningless but time is everything
Warren Buffett is renowned for being one of the world’s most successful investors. However, Housel points out that Buffett has accumulated his net worth of about $120-billion over the course of his lifetime, from the age of 14 with $5,000 to his current age of 91. “What stands out is that 99% of Buffett’s net worth was accumulated after his 55th birthday; 97% was accumulated after his 65th birthday. This is important because we spend so much time trying to figure out how he did it. We go into grand detail about how he thinks about business models and market cycles which are all important topics, but 99% of his net worth is tied to his time horizon or the amount of time that he has been investing for,” Housel says. He points out that if Buffett had retired at the age of 60 like most people, he would most likely not have become a household name. “Is he a great investor? Yes, but his real secret is that he’s been a good investor for 80 years. That’s the secret to 99% of his success,” Housel says.
He says most investors think they are long-term investors. However, for some, long-term is a year or five years.
“A good definition of long-term is between 10 and 20 years. The central failing of most investors is underestimating the amount of time needed to put the odds of success in their favour,” he says.
Key takeaway: It’s not about chopping and changing your investments, trying to second-guess when share prices will fall and when they will rise. Your best bet is rather to adopt the simple approach of holding investments over the long term and reaping the benefits of compound interest. Staying invested for the long term (at least 10 to 20 years) is key to building wealth.
Managing your expectations
Most Americans today look back on the 1950s with nostalgia as “the best decade ever”. The median household income adjusted for inflation in 1955 was $29,000 a year for the average family, and in 2020 it was $64,000 adjusted for inflation. The average new home in the 1950s was 37% smaller than it is today, and food took up 29% of the average household budget versus 13% today. Housel attributes the nostalgia for the 1950s to the fact that wealth inequality was very low, relative to today. “Back then, there were no chief executives making 1,000 times what their workers earned; athletes were not earning $30-million a year… It was easier for ordinary families to keep their expectations in check because there were not a lot of very wealthy people raising the bar for what a good life was meant to be,” he says. Housel says that if your expectations grow faster than your income, you will never be happy with your money.
Key takeaway: Becoming happy with your money has as much to do with managing expectations as it does with growing your income. Despite being one of the richest men in the world, Buffett still lives in the same house he bought in 1958. Instead of upgrading his lifestyle, he simply kept reinvesting his money.
Risk is what you don’t see
Housel related the following anecdote: Harry Houdini was one of the most famous magicians of all time. One of his popular tricks was inviting the largest, strongest man in the audience to punch him in the stomach as hard as he could. Houdini could flex his stomach in a way that he could absorb any man’s punches. One day after a show in 1926, he invited a group of college students backstage. One of the students, Gordon Whitehead, walked up to Houdini and started punching him in the stomach. He didn’t mean any harm. He thought he was simply doing the trick that he had just seen on stage, but Houdini was not prepared and suddenly he was in a lot of pain. He couldn’t get out of bed when he woke up the next morning because his appendix had ruptured the night before, almost certainly from Whitehead’s punches. Houdini died a few days later.
“What’s astounding is that he was the world’s foremost authority on surviving big risks. He could survive being wrapped in chains and thrown in a river because he had a plan for it. He knew it was coming… What killed him was an innocent college student’s punch that he didn’t see coming,” Housel says.
The Association for Savings and Investment South Africa (Asisa) reports that interest-bearing portfolios attracted the bulk of net inflows for the 12 months to the end of June 2021. In other words, investors spooked by Covid-19 and the market’s reaction to it pulled their money out of equities and into “safer” investments. However, Sunette Mulder, senior policy adviser at Asisa, says most of these investments made over the year to June 2021 would have missed out on the stock market recovery. “A successful investment strategy requires a long-term commitment to a well-diversified portfolio, which includes exposure to equity, together with an understanding that it is time in the market, as opposed to timing the market, that makes all the difference,” she says.
Key takeaway: The answer is diversification so that you can ride out the storm and smooth out your losses with the gains you make. However, reacting to a risk post-event simply ties in your losses without giving you the opportunity to recoup them. DM168
This story first appeared in our weekly Daily Maverick 168 newspaper which is available for R25 at Pick n Pay, Exclusive Books and airport bookstores. For your nearest stockist, please click here.