There is an old article, from 1996, called “The Magellan Myth” written by Duff Young.
In that article the author discussed the fact that most investors had a terrible timing when they used to buy and sell assets, even when they were assets such as the Magellan Fund of Peter Lynch.
Regarding the article, 50% of the investors who bought the fund during that period lost money.
But, how is that possible with a fund that was averaging 30% returns per year during that period?
Well, as per Young, by the simple fact that those investors had a very poor timing.
As for the data used by Micropal, a company that investigates funds, the average period the customers had the portfolio was 12 months.
What does it mean?
It does mean that there were many investors who had the fund for one, two or three years, and many investors who had it for one, three or seven months, for instance.
This takes us to an important conclusion: some of the ones that invested for a few months were not really investors.
An investor is that one who does buy an asset with a long-term view, whether as business or as an idea.
Everything shorter to it is not something we can call an investment really.
It is possible that in the initial moment this person had an “investor” mentality, but when the first “storm” came showed that he was not a real one and ended up selling and failing instead of keeping the best fund of that era.
What is the cause by which investors buy a fund and sell it months later with loses?
This happened, happens, and will happen because many of those who approach the world of investing for the long-term do it with the wrong mentality.
They thought that by buying the “best asset” they were doing the best thing, and that this “best asset” would give them great returns and profits.
In this case it worked like this:
The great majority of investors and hot money came from excess cash flows belonging to thousands of business and wealthy professionals, which searched for alternatives where to put that money.
As they inform themselves they can see there are certain funds or stocks that have the best performance.
For instance, looking at the newspaper data they could find something like this:
- Magellan performance during last year: 65%.
As Magellan was in the first positions of any performance ranking those years many investors used to buy the fund when it was doing better.
invested for a long period of time know that assets do not rise an average of 65% forever.
Some rises of 65% can be followed by corrections of 15 or 20%, which could be followed by a reaction and a 20% rise.
If that happens during two years we would have a total return of 65% during those two years with an average of 30% per year approximately.
In this example you can see where the problem is.
Every fund or stock has corrections.
If the so called investor buys after the fund has risen 65% and the fund falls 20% in price, many of those investors get scared and sell at that moment.
They think the fund has stopped working.
But the fact is that it was a normal correction after a huge rise.
If the investors decided to keep their investment they would have been better off later.
The only thing they needed here was “patience”.
This can serve us as a lesson when determining how we take our decisions for long-term investing.
There are occasions where the asset has had a great performance and the following years are bad, but if we stand our ground, we will most probably find some success later, after having patience.
Timing and the problem of emotions in the stock market
The timing based on short-term emotions is not advisable for long-term investments since they require patience and that word is “incompatible” with the anxiety to win money quickly.
There are authors that attacked this article because they say that the author worked in the brokerage industry, more interested in the short-term trading span.
Apparently, the article attacked those investors who bought the fund without brokers or fund advisory, in other words, those who bought the fund directly.
Regarding the study that group was more prone to buy and sell in the worst moments making the final average holding period of only 12 months.
However, and independently of how exact or not the data is, we can be sure that the main thesis is quite accurate and it works for any country and time.
It is like a fundamental principle of how things work in this reality.
This principle tells us that emotions and passions influence a lot of people when they have to act.
As we know one of the biggest mistakes you can do when you are approaching the world of the stocks markets, is try to invest following your “emotions”.
When you invest with your “head” you will end up holding your assets for a long period of time and buying them preferably when there are bad moments, not when things are “good”.
You can buy the best assets like the Magellan fund and still lose money.