How To Make Great Investment Returns Over The Next Several Years
I strongly believe that at this moment and also over the next 1-2 years there are going to be some unbelievable investment opportunities for long-term investors in the markets. That is the good news.
The bad news is that they're not going to be that easy to make because of three important factors -
- Timing
- Volatility
- The role that short terminism plays in today's lifestyles
Timing - Assume It's Always Going To Go Wrong
Timing is the nemesis of every market participant. If any trader or investor had a Genie’s lamp with one wish of how to improve their results, most if not all would say ‘improve my timing’.
How many times for example have we been right about the future direction of the markets only to lose money because we were too early or too late?
A classic example of this, where an enormous amount of money was lost, was back in the tech boom around the turn of the century. Many people thought the madness was overdone and so shorted shares only for stock prices to continue higher with even more irrational exuberance.
Timing, or lack of it, is a problem that has to be overcome and dealt with if large profits are to be made over the next several years.
Volatility – There’s Little One Can do To Avoid It
Be prepared for major volatility over the next few years. And volatility often leads to drawdowns, sometimes savage.
The definition of drawdown is the percentage price drop from a stock’s high or from where you bought it. So a 25% drawdown would mean a stock that was at £2 is now trading at £1.50.
In my view it’s not going to be possible to earn the great profits on offer over the next few years unless you can mentally deal with the volatility and drawdowns.
Short Terminism – Don’t Get Swayed By The Randomness
One of the main problems about trying to make decent returns via investing or trading is that the world and information spins a lot faster these days.
The media bombasts us with ever increasing loads of information - stories - articles - comments which makes it incredibly difficult to keep an eye on the longer term picture.
What this short terminism has done to investors is to make them want (and even demand!) everything today, or certainly by next week.
Even the average long-term investor seems to want to buy a stock in the morning, to see it close higher by the evening, and then for it to continue to rise everyday until it’s sold.
And not only that, a stock bought with a 1-2 year view is often followed tick for tick in real-time. Chances are the owner gets slightly depressed when it closes down 2% one day but a smile quickly appears when it pops back up 3% the following day.
However, personally I think that to check daily or even weekly movements is dangerous when concentrating on the long-term picture.
If you want a chance at making decent returns over the next few years you’re going to have to deal with and cut out short terminism.
How To Defeat The Problem Of Timing
Firstly, as I suggested above, you must accept that your timing will be off more often than it is on. Also you must realise that if you do get things spot on it’s probably more down to luck than your inherent skill.
The way that I deal with the problem of timing is simple –
- Accept it’s always going to be off
- Don’t use all your powder (capital) at once
Point 1 is self-explanatory.
Point 2 means that if I’m going to risk £5,000 in buying the ABC stock my first purchase is going to be about £1,500 to £3,000. I call this a foundation trade. It's not strictly true to say I’m in a win-win position but this is my way of looking at the problem.
If I were to buy the stock at £3.00 and it never looks back I will benefit but obviously not as much as if I had invested the full £5,000. But if the stock moves lower I will use up the balance of the £5,000 to buy more at cheaper levels.
Be careful though on commissions because even at £10 a trade it starts to get expensive on bargain sizes of less than £1,000.
How To Defeat Short Terminism
One of the keys, if not the main one, to successful investing is to get your time period right.
Are you a short-term trader (holding stocks for 1-30 days), a medium term trader (1 month – 6 months) or a long-term investor (6 months to several years).
A long-term investor who is influenced by what is happening at the short-term level is probably a disaster waiting to happen. The chances are they’ll buy a stock thinking it has the potential to say double over a year but sell it a week later because they don’t like the short-term outlook for the general stockmarket. As most of us know (and have experienced in the past), the stock probably takes off to the moon as soon as we’ve sold.
Personally I’m a long-term investor and so care little if anything about what happens to the stockmarket and stock prices today, this week or even this month. I can literally go for weeks without ever looking seriously at the price of my stocks.
I learned the hard way that if you invest for the long-term but base your decisions on what is happening today (or happened yesterday) you’re generally going to buy high and sell low.
So to defeat short terminism do the following -
- Respect your time frame and don’t follow your stocks on a daily or even weekly basis (apart from a quick glance here or there)
- If you don’t follow the markets on a day to day base but want to know if a stock(s) falls to a certain level use Yahoo Finance to send an email alert. This means that if the XYZ stock is at £5 and you want to know if it trades at £4 you’ll receive an email
- Pay little if any attention to most of the financial commentators because they always tell people the market is going up when it's rising, and heading lower when it's falling
- Start to view CNBC and the other financial channels as pure marketing mediums. So instead of receiving good and impartial information you're probably being fed subtle sales pitches (stockbrokers creating business, US corporate/economic propaganda etc)
- And above all as I've said before, realise that if you're a long-term investor so whatever happens today (unless significant) is just news and general market noise
How To Deal With Volatility
I deal with volatility by expecting it.
When I buy a stock I expect it to move all over the place because that’s what stocks normally do, especially when the economy is booming or in turmoil.
When I buy a stock I expect it to fall 10%, 20% or even up to 50% when buying into volatile sectors like Gold or Technology.
Staggering your purchases also helps tremendously when dealing with volatility and drawdowns.
Summary
The above are some ideas that if followed should hold long-term investors in good stead over the next several years. Of course though the trick is to find stocks with real potential.
In the last two newsletters I’ve suggested a couple of shares, ITV & Woolworths, which I’ve bought and am ready to buy more should they fall. And on the following page there’s another interesting company which I believe shows real potential for the next 2-10 years.
