Even the Pros Can’t Do It the Short-Term Way

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Despite evidence of how time is a crucial ingredient in generating lasting wealth from stock market returns, there are still significant groups of market-participants who prefer to treat the markets like a casino, going in for one quick trade after another.

Thing is, the more often a person trades, the more he or she loses. And lest you think professional money managers have the Midas touch, that’s a notion that might be very mistaken.

A fascinating study published in April this year by researchers Bidisha Chakrabarty, Pamela C. Moulton and Charles Trzcinka – from American universities, Saint Louis University, Cornell University, and Indiana University respectively – showed how, in a period spanning 1999 to 2009, 96% of institutional money managers and pension funds had executed short-term trades lasting less than one month; and perhaps not surprisingly, these trades generated negative returns on average.

What’s also interesting, are the plausible reasons behind these trades given by the researchers: the money managers and pension funds were driven by a desire to look ‘busy’ and very likely fell prey to overconfidence as well.

In particular, the latter reason affects not just the professionals, but people in general. Think about it, for those who drive, would you describe yourself as an above average driver? What happens now if I put everyone in the same room?

All of a sudden, I’ll be getting 70 people out of a 100 saying they’re better-than-average drivers, which by definition of the word ‘average’, is just impossible.

This is just an interesting, anecdotal story of describing how people in general are prone to bouts of overconfidence in our own abilities. But more importantly, this over-estimation of our own skills seeps into an often-misguided view on how well we can do in the financial markets, especially with short-term trading.

Yet, if even the pros – with their vast array of analysts and proprietary research – can’t seem to get it right with short-term trades, what chance would individual investors like me and you have when trying to play the short-term game? Very little.

So, if short-termism can’t work, then let’s go the long-term route. And, the evidence there is strong.

Over the past 25-odd years since the start of 1988, the Straits Times Index (SGX: ^STI) in Singapore has gained 281% from 834 to 3,176 points and that’s despite some of the difficult times our nation has faced, such as the 1997 Asian Financial Crisis, the SARS outbreak in 2003, and the Great Financial Crisis of 2007-2009.

The STI’s gains in that period works out to a compounded annualised return of around 5.3% per year and if dividends are tacked on, it’s not hard to imagine the annual return figure becoming 7% to 8% a year. Those are returns you can get for just buying and then holding the index.

I’ve also shown how the odds of losing money in the STI decreases dramatically when holding periods are lengthened. Those are advantages that we, as investors, cannot easily ignore.

And lest you think investing in the STI is some abstract concept with no real economic value – it’s not. Investors in exchange-traded funds that tracks the STI – the SPDR Straits Times Index ETF (SGX: ES3) and the Nikko AM Singapore STI ETF (SGX: G3B) – are holding a basket of actual shares of 30 of the largest publicly-listed companies in Singapore.

The stock market here, over the long-term, reflects the economic growth of Singapore. Over the short-term however, it gets dragged all over the place by the capriciousness of human emotions.

In the market place, we’re given choices all the time. And when confronted with a choice on how I’ll make informed-bets on the market, I’ll rather place my odds on something I can estimate with reasonable certainty – the economic well-being of Singapore over the long-term – rather than on how exuberant or pessimistic market participants might be over the next 3 months, 6 months, or even a year.

And as a final note, if you think you are a better-guesser than most on whether the market might dart upwards or down over the next 30 days, remember: even the pros can’t get it right.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chong Ser Jing doesn’t own shares in any companies mentioned.