During extreme periods for the market, investors often make decisions that undermine their ability to build long-term wealth. Especially in light of the recent market ups and downs, it can be very valuable to look back in history and study the timeless principles that have guided some of the greatest investors through both good and bad markets. We can learn many important lessons about the mindset required to build long-term wealth!
- Avoid Self-Destructive Investor Behavior. “Individuals who cannot master their emotions are ill-suited to profit from the investment process.” – Benjamin Graham, Father of Value Investing, author of the Intelligent Investor and mentor to Warren Buffett. Emotions can be our greatest enemy when it comes to investing. The average investor has sacrificed almost 3/4 of their potential return compared to the stock market. This gap is called the “investor behavior penalty.” This is due to engaging in negative behaviors like chasing the hot fund manager, stock, or asset class, avoided areas of the market that were out of favor, attempting to time the market, or just abandoning their investment plan. The greatest investors know that building long-term wealth requires the ability to control one’s emotions and avoid self-destructive behavior.
- Understand That Crises Are Inevitable. “History provides a crucial insight regard market crises: They are inevitable, painful, and ultimately surmountable.” – Shelby M.C. Davis, Legendary Investor. History has shown that the stock market will always encounter crises and uncertainty. The greatest investors understand that short-term underperformance and volatility is unavoidable. 95% of the top fund managers from 2004 to 2013 fell into the bottom half of their peer groups with 73% of them falling into the bottom quarter of their peer groups for at least one three-year period. Even though these professional managers delivered great long-term returns for ten years, almost all of them experienced some difficult short-term stretches. The greatest investors understand that we shouldn’t overreact to short-term fluctuations of the market.
- Be Patient. “Though frustrating, stretches of disappointing results for the market are not unprecedented. History shows however, that these difficult stretches have been followed by periods of recovery. Why? Because lower prices increase future returns.” – Christopher C. Davis Portfolio Manager, Davis Advisors. History shows that after disappointing 10-year periods for the stock market, the average return for the next 10-year period is 13% per year! Nobody knows what the next 10 years will bring, but investors with long-term goals should look into maintaining or even adding to their stock allocation after a downturn in the market. Why? Because low prices help increase future returns and opportunity.
- Don’t Let Emotions Guide Your Investment Decisions. “Be fearful when others are greedy. Be greedy when others are fearful.” – Warren Buffett, Legendary Investor and Chairman of Berkshire Hathaway. Building long-term financial wealth involves counter-emotional investment decisions. Investors should buy when there is maximum pessimism with the market and sell (or resist buying) when there is maximum euphoria with the market. The stock market boomed from 1997 to 1999 with record amounts of money flowing in 2000. Unfortunately they just got in to experience terrible years of returns from 2000 to 2002. Many of the same investors sold during this downturn only to see the market go up over 30% in 2003! This happened again in 2008, when many pulled out of the stock market at the bottom, missing the subsequent double digit returns a few years later.
It is important to understand that periods of market uncertainty can create wealth-building opportunities for the patient, diligent, long-term investor. Taking advantage of these opportunities, however, requires the willingness to embrace and incorporate the wisdom and insight offered by the greatest investors. History has taught us that investors who have adopted this mindset have met with tremendous success.