In his new book – The Psychology of Money, Morgan Housel provides a great illustration of how success in investing is achieved by remaining calm through ‘punctuated moments of terror’ in the market. Here’s an excerpt from the book.
Consider what would happen if you saved $1 every month from 1900 to 2019.
You could invest that $1 into the U.S. stock market every month, rain or shine. it doesn’t matter if economists are screaming about a looming recession or new bear market. You just keep investing. Let’s call an investor who does this Sue.
But maybe investing during a recession is too scary. So perhaps you invest your $1 in the stock market when the economy is not in a recession, sell everything when it’s in a recession and save your monthly dollar in cash, and invest everything back into the stock market when the recession ends. We’ll call this investor Jim.
Or perhaps it takes a few months for a recession to scare you out, and then it takes a while to regain confidence before you get back in the market. You invest $1 in stocks when there’s no recession, sell six months after a recession begins, and invest back in six months after a recession ends. We’ll call you Tom.
How much money would these three investors end up with over time?
Sue ends up with $435,551.
Jim has $257,386.
Sue wins by a mile.
There were 1,428 months between 1900 and 2019. Just over 300 of them were during a recession. So by keeping her cool during just the 22% of the time the economy was in or near a recession, Sue ends up with almost three-quarters more money than Jim or Tom.
To give a more recent example: How you behaved as an investor during a few months in late 2008 and early 2009 will likely have more impact on your lifetime returns than everything you did from 2000 to 2008.
There is the old pilot quip that their jobs are “hours and hours of boredom punctuated by moments of sheer terror.” It’s the same in investing. Your success as an investor will be determined by how you respond to punctuated moments of terror, not the years spent on cruise control.
A good definition of an investing genius is the man or woman who can do the average thing when all those around them are going crazy.
Tails drive everything.
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