Know yourself, and then get to know your investments…
While most of the financial blogosphere is spending time recapping last year, making predictions, or crowing about or lamenting annual performance, I’ll take a different tack and get philosophical. One of the things that most investors lose sight of is that every economic moment is either a continuation or a reaction to the past. Thus, if you want to know where to put your money at any given moment, it behooves you to look at what’s worked well and poorly up to the current moment and try and contemplate what that means going forward. Will the current cycle continue on or will it be subject to a break? Depending on your investment horizon that means different things.
The economy moves in cycles, and each moment of the cycle is planting seeds that will bear fruit (ripe or rotten depending on your viewpoint) at different points going forward. The biggest failure most investors make are analytical errors in forecasting. But I don’t believe that’s the most costly kind of error. I think the single biggest killer of investment performance is widening or narrowing the time horizon of your investments based on external stimuli. Buying Amazon at 90x earnings implies a belief that Amazon is an industry changer with large growth prospects and an almost infinite business runway ahead of it. To freak out and dump this company because of a European debt crisis, a quarterly earnings miss, natural disaster, or some other short-term hiccup implies that there was no rhyme or reason behind the initial purchase. You were speculating. The primary reason you should dump Amazon as an investment you made at 90x earnings (implying you thought it was cheap at that multiple based on an appraisal of the business) s because a new competitor changes the way people buy consumer products and Amazon is now toast or significantly impaired as a company forever.
Depending on your time horizon, some issues become almost negligible. For instance, if your time horizon is 100 years, your universe of researchable equities shrinks dramatically, as only a few industries pass the test of being able to withstand 100 years of technological obsolescence and progress. It’s also interesting to note that those industries that do pass this thought exercise are not even all the ones that have been around for 100 years to date, either. In short, if your time horizon is 100 years, you need to spend a lot of time thinking about what the next 100 years will look like. You also, more critically, need to think about all the variations around that theme, and then think about where you can go wrong, and think about how you hedge out your risks in the most effective way.
This is a much different way of structuring your investment process than someone who has a horizon of 30 minutes.
So, if you’re a pension manager with a set of retirement liabilities that will hit in 10-15 years, you should ask yourself why you want to invest in High Frequency Traders who are jumping in and out of securities on a microsecond basis?
