The Advantages Of Long-Term (Patient) Investing

“Patient” capital sometimes refers to investments that don’t expect an immediate return. Some investments, however, do include some component of current returns — but also require some “patience” to gain the full potential of the total possible investment profits. Real estate equity investments generally fall into this group.

Short-term profits can often entice those who are new to any particular investment market. But adopting a long-term horizon — dismissing the “get in, get out and make a killing” mentality — is often an advisable strategy for many investors.

It’s not impossible, of course, to make money by actively trading stocks or bonds in the short term. But investing and trading are very different ways of making gains from any market. Trading involves different, and additional, risks that “buy-and-hold” investors don’t necessarily experience – and the recent history of “genius” hedge fund managers seems to show that, over time, it’s difficult for anyone to spot, and time, great investments in a way that produces better returns than the overall market.

Warren Buffet, and Long-Term Investing Focused on Earnings Power

Warren Buffet is perhaps one of the world’s most famous “long-term “ investors. Mr. Buffet wrote that when he and his partner Charlie Munger buy stocks, they think of them as “small portions of businesses” and try to see the earnings power of these businesses over the next five years or more. “In the 54 years we have worked together, we have never forgone an attractive purchase because of the macro or political environment,” he said.

Mr. Buffett said he didn’t worry about real-estate prices or stock prices during the Great Recession. “Could anyone really believe the earth was going to swallow up the incredible productive assets and unlimited human ingenuity existing in America?”

Potential “Transaction Tax” May Highlight the Perils of Active Trading

Recent proposals in U.S. presidential races concerning a “financial transaction tax” may focus additional attention on the long-term vs. trader debate. Akin to imposing a “sin tax,” the proposals operate from the premise that trading too much hurts returns, and is hazardous to an investor’s wealth – and that the less we do of it, the better off most of us will be.

Financial transaction tax endorsers include everyone from Bill Gates to David Stockman, the former budget director for Ronald Reagan. But is trading stocks and bonds really so harmful that it belongs in the same category as cigarette taxes and other behavior-modifying measures?

There’s a good argument that it does. Two finance professors, Brad Barber and Terrance Odean, published a report in 2000 that examined the trading records of over 66,000 households. According to the study, the 20 percent who traded the most earned an average net annual return that was 7.2 percentage points less than that of the least active investors.

Why Long-Term Investing is Often a Preferable Approach

One primary obstacle for short-term traders is taxes. Every time a stock is sold, taxes become due. The below chart shows how the differences would have played out up until a few years ago, when the capital gains rates were still at 15% (these have since increased to 20%, but the ordinary income tax rate has since gone up too).

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Another factor hurting the returns of active traders is trading commissions – the more trades one makes, the more money one is paying in commissions. Losing trades are also difficult to manage, and often require the use of stop-loss mechanisms to minimize potential trading losses. Long-term investors, on the other hand, look for solid companies that will increase in value over time, and may view short-term price drops as a chance to add to their position rather than a setback.

Why would short-term investors hurt themselves by trading in this manner? Some theorize that the behavior is like gambling, with its danger of addiction (akin to cigarettes). There is some evidence of this; in Taiwan, when a national lottery was introduced, trading on the stock exchange fell by 25 percent.

Mr. Odean chalks up much of the trading to overconfidence. Most of us think we’re better than the average investor; and the internet gives us the illusion of feeling well informed, even as we forget that that others have likely already read the information we thought gave us unique “insight.”

Most importantly, beyond what we must do to make regular investments, rebalance those investments back to the target mix, and to pull money out for necessary spending, every additional trade arguably pushes investors down a slippery slope of delusion. Most investors are not professionals. They (we) are not smarter than the market. And perhaps the sooner that we learn that lesson, the less “taxing” our investment experiences will be.

Lawrence Fassler
Corporate Counsel
Lawrence has over 15 years' experience as a corporate attorney and has also run a real estate construction business. He previously worked with Realty Mogul, AVE (acquired for over $4 billion), Shearman & Sterling in NYC, and Cooley in their Sand Hill Road office.