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The investment industry is filled with a number of wise old sayings.
Be fearful when others are greedy. Be greedy when others are fearful.
Invest in yourself.
Markets can remain irrational longer than you can remain solvent.
Another one you hear all the time is, “Invest for the long-term”, and for good reason. Despite recession, wars, or political uncertainty, markets have historically gone up in the long-term. In this case the long term can refer to 50 years, or more. A long term investment requires significant patience and discipline. Active investors trying to time the market often have the deck stacked against them. Miss just a few of the best days in the year and your returns pale in comparison with an investor who stayed invested in the market.
Elite investors such as Warren Buffett, Benjamin Graham and Charlie Munger had a similar view when it came to holding periods. For instance, Buffet has owned shares of Coca Cola for 30 years and it remains one of his largest stock investments.
However value investors should not make the mistake of equating long-term investing with “buy and hold.” Buy and hold is a passive strategy used by investors who buy a security and hold it basically forever, periodically adding to their position over time. In fact these investors are the opposite of value investors in a sense because they are typically price-insensitive, buying no matter what the price and circumstance. Value investors on the other hand want to purchase stocks at a discount to intrinsic value and are very price sensitive.
There is a contradiction in Warren Buffet’s investment style that illustrates how he, and by extension value investors like him, is different from buy and hold investors. Even though he says things like “Our favorite holding period is forever”, and has owned Coca Cola forever, research finds that he has a median holding period of just a year. Over 26 years of Berkshire Hathaway’s public filings, Buffet only held onto 20% of stocks for more than two years.
Patience is a Virtue for Long Term Investing Success
In contrast to buy and hold investors, who have a long-term holding period, value investors have a long-term view of investing. These investors carefully study and research a specific company. They try to understand the key drivers of the business, and attempt to come up with a valuation of the intrinsic value of said firm. If the conditions are right, and price permits, the patient value investor will open a position. If not, they may wait until the right opportunity presents itself but he or she will not buy just for the sake of buying. This idea of waiting things out, planning for different eventualities and outcomes, and having this sort of long-term view is what differentiates value investors from buy and hold investors.
Once the position has been established, the value investor may maintain the position for several years or even longer. A value investor can expect to have low portfolio turnover and a long holding period because it takes time for stocks to appreciate from the moment the position is made.
Value investors believe there are inefficiencies in the market. These inefficiencies, whether they are due to cognitive and behavioral reasons or more technical reasons such as information not being readily available to the entire market, can cause stock prices to deviate from the true valuation of a business. It takes time for these inefficiencies to resolve themselves, and thus value investors have to wait for the market to catch up to their valuation of the business.
Long Term Investment: Temperament over intelligence
The value investor is not overly concerned with the performance of the overall stock market. Value investing represents a commitment to the process of investing long-term, and the position is maintained regardless of the price movements in the stock market. Portfolios are repositioned only when necessary.
In fact, it’s exactly those times when the market is frothy that a value investor defines himself. As Buffett says, “Temperament is more important than IQ”. Great returns come from the decisions made in those tough times, and depends on whether the investor follows the processes they have laid out for themselves. Additionally, value investors can profit immensely during lean times, when the stock market is on the down and outs. In these conditions, the value investor can go shopping for distressed assets that offer incredible value if all the criteria checks out.
They never chase performance by purchasing the high flying momentum stocks. Jumping on the bandwagon this way is a clear case of group mentality and anytime a stock is being hyped, it’s likely that it will be overvalued by the time you are ready to buy. It’s best to stay away and operate solo, otherwise you may end up doing worse than if no action had been taken at all.
Value investors are not market timers. Instead, they are investors who are committed to their value oriented philosophy and employing a long-term outlook to their investing. Margin of safety, a key value investing concept, highlights this outlook. One reason value investors build in a margin of safety in their investments is because they know it takes time for an investment to recognize its value. In between it may go up, or down and if it goes down the value investor has a built-in cushion.
A long term investment outlook also necessitates that a value investor only liquidate a position when the underlying investment no longer meets his/her criteria (Read: When to Sell Stocks). This goes hand-in-hand with having a good temperament, as it takes guts to stick to your guns when things aren’t going your way.
The final word
Having an ultra-long term view of investing requires a great deal of discipline and patience. Many analysts and financial wizards are revered for their ability to price a stock but less are granted glory for their outlook, temperament and long-term thinking. Marrying the two effectively will make you a formidable investor.
Hughes, John S. and Liu, Jing and Zhang, Mingshan, Overconfidence, Under-Reaction, and Warren Buffett’s Investments (July 5, 2010). Available at SSRN: https://ssrn.com/abstract=1635061 or http://dx.doi.org/10.2139/ssrn.1635061
Jiva Kalan is a writer whose work has been featured on DailyFinance, the Wall Street Survivor, Plousio and Financial Choice.