In the past few months I’ve presented the most common reasons why physicians get sidetracked with their investments—namely the constant media blitz and our own overconfidence. Now it’s time to see the consequences of these distractions and give you a dose of preventative medicine.
Staying disciplined in investing is similar to those days in residency when you were on call in the ICU: dead tired in the morning after being up all night, you think to yourself, “I can’t do this anymore.” Let‘s take a look at the type of discipline you need to be a successful investor. The graph below shows the monthly returns of the US stock market over 20 years (exhibit A).
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If you were presented with this image in the ED, you would be getting the paddles charged up for a 360J shock. What you’ll immediately notice is the extreme fluctuations in the monthly returns of the stock market. Now here’s the shock: you have to live with this volatility and it is inescapable. Further, the magnitude of the declines is greater than the magnitude of the gains. If you want the upside, you have to suffer through the downside. The black line represents the average of all of this—an average monthly gain of 0.7%. Ask yourself: am I willing to potentially lose 15% in a month just to gain less than 1% a month on average?
So let’s say you can’t stomach the pain and you keep getting in and out of the stock market. How much can you really lose? It turns out it’s a bundle. Take a look at the past nearly 40 years of data (exhibit B).
The chart shows the growth of $1,000 invested in the US stock market starting on January 1, 1970 and ending on December 31, 2008. Out of the roughly 9 thousand trading days, missing the few best days in the market would have cut your returns by nearly 75%. Now think about this—missing 25 of the best days is only 0.28% of the trading days in the past 40 years (assuming 9,000 trading days). You may as well invest in a CD and forget about it. Some of you may be wondering what would happen if you missed the worst days in the market. In that case, of course your returns would be far higher, but most people are affected far more by losses than gains, and so it makes sense to look at it this way.
You might think that you’re not prone to these types of mistakes, but studies done on individual investors returns show otherwise. A widely known study, which is repeated periodically, reveals that the average investor dramatically underperforms not only the stock market but doesn’t even keep up with inflation (exhibit C).
Why? Most investors lack the discipline to ride out the extreme fluctuations and so they buy high and sell low, which violates a basic principle of investing.
It’s time for a little vaccination. How can you stay disciplined in investing?
Think long term. You hear this in the media all the time, but what I mean by long term is not next month or next year. Long term is your entire investing lifetime—well beyond retirement. You have to take a “’til death do us part” attitude toward your portfolio. By thinking in this way, short term fluctuations matter far less.
Turn off the TV and unsubscribe to magazines. Toss every piece of financial pornography in the trash. Watch ESPN and the Discovery Channel instead of CNBC and Bloomberg.
Stop looking at your portfolio. You don’t have your house appraised every day do you? (if you do, then I have no hope for you.) Then stop appraising your portfolio every day. The best way to reduce the ups and downs of your portfolio is to look less often. And delete your watchlists and portfolios from your Yahoo home page.
Think about risk tradeoffs. While short term noise affects you emotionally and causes you to make irrational decisions, remember there is a far greater hidden risk eating at your portfolio: inflation. Your pay already lags inflation. Don’t compound this risk with poor investment discipline.
Get on with your life. The stock market is smarter than you. Just because you got in to medical school and a competitive specialty doesn’t mean you’ll be rewarded with good investment returns. The market doesn’t know and doesn’t care. Instead of fighting the market, accept it by swallowing a big pill of humility. By focusing on enhancing your life, you’ll ultimately enhance your returns.
Setu Mazumdar, MD practices EM and he is the president of Lotus Wealth Solutions in Atlanta, GA www.lotuswealthsolutions.com