Why It Pays To Be Patient

Guess what is the toughest thing for many investors to do? Yeah, this article’s title is a big hint. The toughest thing an investor can do is being patient and doing nothing.

But what does “doing nothing” even mean, actually? Turns out, when people buy into stocks, their innate behavior tends to tilt toward watching the fluctuations of stock prices and consequently, they feel an urge to act on these price movements.

They then end up engaging in what we call “timing the market” as they try to find the best possible entry and exit points. This is despite how it is nearly impossible to consistently forecast the short-term future of stock market prices.

Shorter trading period

This is also evident from the decrease in holding period for a stock over the years. According to data from the financial advisory firm LPL Financial, while the average holding period of an American stock by an investor in the country was around 7 years in the 1940s, it has been trending down to an average of 6 months by 2010.

Patience is a virtue that most stock market investors seem to have forgotten, which might be due to the promotion of get-quick-rich schemes and various media sources continually driving the temptations of retail investors to do more trading than they should.

It is in contrast to the advice that former American president Ronald Reagan once gave: “Don’t just do something, stand there!”

Average investor returns

Source: Dalbar

According to Dalbar, for the twenty years ended  31 Dec 2010 in the USA, the S&P 500 Index (a stock market barometer there) averaged an attractive annualized return of 9.14% a year as compared to the average equity fund investor in the country who earned a return of only 3.83% per year. Why is there such a drastic difference?

Studies have shown that investors tend to exhibit poor judgment due to their irrational behavior by buying at market tops and selling out at bottoms, which leads to dismal returns. In other instances, people might lack the requisite patience and end up chasing trends by focusing on what is happening right now.

Time and again, these market participants over-estimate their capabilities in earning market-beating returns but are yet strangely convinced of their own abilities. Thus, when it comes to your investments, if you feel your emotions are getting the best of you, go back to Reagan’s advice – Do nothing. A conscious and thoughtful decision to do nothing is still a form of action.

Patience pays off

There are several reasons why patience can pay off handsomely. The first and most neglected one is that long-term investors benefit from growing dividend income when companies do well. Take for example Vicom (SGX: V01), Singapore’s market leader in commercial vehicle inspection and testing. The company’s dividends have almost doubled from 9.25 Singapore cents in 2008 to 18.2 cents in 2012. Dividends are a very important part of long-term stock market returns, as evidenced from research done by investing firms like Tweedy, Browne.

Secondly, the odds of losing money decline considerably in tandem to how long we hold our shares. Let’s consider three different holding periods for an investor in the Strait Times Index (SGX: ^STI). With a holding period of one year and 10 years, losses occurred 41% and 19% of the time respectively. However, when the holding period increases to 20 years, there have historically been no losses.

This may be the reason why billionaire investor Warren Buffett puts long term investing as one of his core principles when it comes to the stock market.

Foolish Bottom-line

People often debate the notion on whether the patient investing strategy of buy-and-hold theory still works and some might even deem it to be too simplistic,.

Nonetheless, patience and a long time horizon have been proven to be a potent combination for achieving positive results in the stock market. To borrow from Tolstoy’s quote, “The two most powerful warriors [in investing] are patience and time.”

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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 James Yeo does not own shares in any companies as mentioned.