Investment Strategy update: The Discovery of Slowness
The discovery of Slowness
The last book I read was a German novel called “The Discovery of Slowness” (in the English Translation) from German writer Stan Nadolny.
The book is a ficticious story about a real person, the famous English explorer John Franklin.
In the book, John Franklin is an extraordinarily slow person who has a rough start into life as a kid. He always needs a lot of time to answer questions or react to things happening. During his life, this weakness turns into a strength. More than once, his slowliness and deliberate long thought process leads to a superior solution compared to the “first impulse”.
For instance once, after their ship goes under, he and his comrades find themselves themselves stranded on a flat corall bank. Whereas his fellow sailors start shouting for help etc., he directly starts to build a platform in order to survive the high tide and thereby saves all his comrades. When he was asked later why he did this he says “As I am so slow, I have to start early”. In another situation, a ship under his command gets in into a storm in the Arctic seas and is at risk to get destroyed by Icebergs. His men start to panic and want to get away. He takes his time and finally contra-intuitively stears the ship into the solid ice as this is the only safe place in a storm and they survive.
During his life, he turns his weakness into a strength by preparing himself extremely diligent for any unforseen problems. As it turns out, good preperation is almost always better than fast reaction time. He is calling this preparation a “system”. One of the core pillars of this system is to have an organization run by two person: One “fast” one for the daily work and a “slow” one for the really important decision.
Despite the book being a good read itself (kind of a Forest Gump story with a Victorian English setting), the more I read the more I had to think of investing and Warren Buffett in particular.
Compared to today’s financial technology (Twitter, High Frequency Trading etc.), Warren and Charlie look as slow as John Franklin in the book. They are so slow that they actually missed the whole first dot.com bubble and many other hypes. However, by creating Berkshire as a permanent investment vehicle and holding a big cash pile, they prepared themselves well for any kind of troubles.
Both have stressed themselves the advantages of being slow many times, either Charlie with his “sit on your ass investing” or Warren’s “Punch Card”. From the outside I would even say that they employ the “Franklin system” to a certain extent. Warren seems to be the fast guy and Chalrie is the one who makes the big changes, like steering Warren to “great” companies many years ago.
For many investors, including myself, this often sounds counter intuitive. Real time stock prices, twitter feeds, mobile phone trading etc. enable us to do everything real time, so why should we care what those old farts say ?
Well, one aspect of this a pretty tangible one: Capital gains tax. In Germany, as a private investor, you pay around 30% capital gains tax. For fun, I made a quick table with the following assumptions:
– Underlying annual return 12% p.a.
– investment horizon 30 years
– Capital gains tax 30%
The following table shows the total return over 30 years depending on how often the portfolio is being “turned over”. So 1 means: The portfolio is turned every year, 5 year means 6 turns within 30 years etc.. These are the results:
| turnover/year | Total gain AT | p.a. AT | in% of max |
|---|---|---|---|
| 1 | 1024% | 8,4% | 35% |
| 2 | 1735% | 10,2% | 60% |
| 3 | 2061% | 10,8% | 71% |
| 4 | 2284% | 11,1% | 79% |
| 5 | 2363% | 11,3% | 82% |
| 6 | 2444% | 11,4% | 84% |
| 7 | 2529% | 11,5% | 87% |
| 8 | 2616% | 11,6% | 90% |
| never | 2896% | 12,0% | 100% |
The results are logical but still striking: Over a thirty year period, if one turns the portfolio every year, the result is roughly 1/3 of a portfolio which remains constant over the 30 years. It is also interesting that the total result increase over-proportionally with every additional year of the average holding period. Already with a 4 year holding period one captures almost 80% of the total yield.
One remark: Please don’t confuse this withe an advice for dax driven investments. This is just to illustrate that slow portfolio turn-over has adnatages.
Secondly, and even more important, being slow in my opinion is the best defense against any kind of behavioural biases. The book was written well before Danial Kahneman’s famous book, but clearly shows that slow thinking leads to better decisions which is especially important in investing.
In the past, I have often reacted to quickly, which resulted either in selling too early or buying to quickly. Especially when prices move significantly within a short term, some behavioural biases like anchoring become very strong. Maturing as an investor in my opinion means among other things, to become slower.
However this is more easy said that done. A large part of the investment industry is hard wired to make investors trade as often as possible in order to generate fees. If you watch CNBC or read investment magazines, they always emphasize to buy or sell things now and not wait until it’s “too late”.
Consequences
As I have written in some of my comments, I am aiming to lengthen my holding periods anyway, but I still think I am too fast. For me, I have come up with 3 very concrete action items which should hopefully help me in becoming a lot slower:
1. I will limit my news feed to high quality sources. I will abandon high frequency stuff like Zero Hedge and Clusterstock
2. I will stop writing monthly performance comments and switch to quarterly
3. I will create my own “soft punchcard”: I will limit myself to either 1 new position or 1 complete sale of a position per month. Increasing or decreasing existing positions is still allowed.
A little explanation for point 3, as this is a real “hard restriction”: This means that at a maximum, I can “switch” 6 stocks a year into new ones. I have to sell one first in one month and buy the new one in the next. As I own on average 25 positions, this should translate over time to a holding period of at least 4 years, preferably more.
This will of course limit my choice to do for instance soem short term special situations, on the other hand I hope that this will further improve my investment decisions and focus better on the long term. I would love to have an brokerage account which would actually limit me on the number of trades I could do in a month.
value and opportunity 
Hi, you mentioned that you stick to high quality news sources (and stop reading Zero hedge and similar ones); which ones do you keep following?
You might want to have a look at my Blog Roll (“AAA Blogs”) plus WSJ and FT. FTAlphaville is great and Matt Levine from Bloomberg.
Hi MMI.
very interesting post again. 19 years ago I decided more or less by gut feeling to invest in 6 stalwart companies and since that time I changed only one position because of disappointing performance of this company after a 10 year holding period. You can see a nice compounding effect if you reinvest the dividends which have increased for all six companies almost every year. Of course, a sale (which I do not plan, holding period as Buffett says, forever) would be tax-free since I bought them back in 1996.
With the value investing approach which I started some 2-3 years ago I sell and buy more often compared to the above mentioned depot, maybe 3 – 4 changes of positions per year which I still consider as slow investing. I like the idea of “cig” to be fully invested in order to force yourself to invest only if you find something “better” than you currently have in your portfolio. And I think this is also one issue with your calculation: you assume a performance of 12% p.a. but ideally you would only change a position if you expect to increase your performance (if you then succeed to do so is another question). So, the main question for me is: can I increase performance by changing my portfolio which would then hopefully over-compensate for the taxes paid. I think at the end of the day there is no clear rule but every investor has to find its own way. But in general I also definitely prefer slowness over hectic trading.
Walter
“Good preperation is almost always better than fast reaction time”. I’ll have to tell that one to my wife. I do like the idea of slowness as a virtue as it would undoubtedly make me virtuous!
And the one buy/sell decision per month is exactly what I’ve been following for about five years now. It’s a most excellent way to ignore the markets on a day-to-day or even week-to-week basis.
#john,
thanks for the comment. I have to admit that I feel ashamed not having implemented the one transaction per month rule a long time ago. I already feel much more relaxed since i set myself this rule and its only 10 days ago….
mmi
“Die Entdeckung der Langsamkeit” is one of my favorite books and it is really something to make you think, escecially nowadays when things move faster and faster wth the constant barrage of. Always on media, email and messaging. I love the way hero of the book dealt with his perceived weakness and converted it into a strength. I do think that this his quite and angle with respect to investing.
I use a “no cash” (in brokerage account) rule as a behavioural trick to slow myself down. It avoids impulse buys as you need to find something to sell that’s worse than the new applicant to trade, and you pay 2x commission. It is easy for outstanding deals, but helps staying put for average ideas that would be tempting to buy with “spare” cash.
#cig,
that’s a pretty good rule as well. What’s your average holding period if I may ask ?
mmi
I’ve only started stock-level trading 3 years ago, so it’s a bit early to say, but if I infer from my turnover rate so far, my holding period should be about 20 years in my large cap segment (which is smart beta of sorts, so naturally doesn’t trade much), and about 4-5 years for the slightly more racy small cap segment (which is where I needed the no-cash rule, it’s so easy to like a new find, and there’s thousands of them).
thanks for the reply. One big warning: Holding stocks during a real bear market is not as easy as it looks on paper and the no cash rule really hurts in such situations because you are already fully invested.
Very true, but I think I’m reasonably well prepared: I’ve already survived bear markets (in funds), and my core holdings are bear-friendly so the portfolio should, touch wood, outperform relatively to the market during bear markets. Also it still leaves the option of some market timing: switching from the bear-proof stuff to the to distressed remains an option (e.g. in a repeat of March 2009 I could sell the steady large caps and buy small caps etc), it’s not as powerful as perfect timing in and out of cash, but then that’s perilous in its own ways.
Somehow strange, why you take the 8.4% for the second year.
I calculated it in the following way, deriving at much lower returns (similar to Roger’s):
After two years I have a pre tax capital of 125.4 (100*1,12^2).
Then I sell. My capital gain is 125.4-100 = 25.4.
Remaining capital after tax (30%) is 125.4 – (25.4*0.3) = 117,8 (this is my starting capital for year 3)
i see your point now… good point.
> In this case I simply compounded the starting value of 100 every year alternatively by
> 12% and 8,4%. In order to come up with an annual compounded growth rate
But isn’t that the problem – It would seem to me this formula would mean you are also taxing your principal amount, not just the gain?
no, I only tax the gain on the prinicpal which is how it works in Germany if you sell your stocks at some point in time.
Hello
Invest only where there is major crisis , war , social unrest , banking panic , currecny crisis , it is much better than stock picking in stable market
So where do we have those conditions today :
Greece Russia Brazil Ukraine Iraq.
Do some stock picking there or even corporate bonds or plain ETF
no,I don’t think that this is my way of investing. I prefer stock picking and long term compounding. As you might have read here in the past, I do invest in crisis areas (like bank subordinated debt or Italy/france during the EUR crisis). However I do require somecertainty about the odds which I don’thave in cases like Russia, Greece or Ukraine.
mmi
I think as value and contrarian Investor we should not limit the number of positions we buy or sell per month, just because we want to act more slowly and want to avoid trading too much.
Our strategy is already one with low turnover, compared to technicals, quants, etc.
Covacoro
Very good and inspiring posting and calculation.
I would like to add several thoughts:
– Many investments may be good in a short period, but not that good in the long period.
That should work for many “opportunity” investments, but as well for many deep valued cigar butt style investments.
Additionally many companies tend to slow their performance by getting older and bigger as it can be seen even at Berkshire Heathaway.
I suppose there is no logic by dogmatically shift the focus toward long time investments and abandon shorter termed investment opportunities but to differentiate the performance expections of new investments regarding the expected time horizon.
Following your calculation I would roughly appraise, that a 16% performance with 1 year time horizon has a comparable quality like a 12% performance with 6 year horizon, and for 0,5 year the comparable performance treshold probably would be around 20%.
Following that calculation one would prefer an opportunity with a fair chance of 14% per anno with 6 years investment horizon toward an opportunity with 18% per anno-performance with 0,5-year horizon, but not toward an opportunity with 30% per anno with 0,5 year horizon (assumed otherwise comparable safety margin and risk profile).
Regarding your consequences:
I understand and back your first point. It may also help reducing the random noise of short term stock markets.
I also understand and back your second point as I also use a quarterly performance comparisons. The signals at the monthly frequence are imho to close to random noise. Sad point: I really like that you use these monthly performance reports to contemplate about themes less related to single shares but the overall share marked. I will miss this regularly level of contemplations more than your monthly performance comparisons.
For your third point I am more sceptical. I would advocate to set it not as a strict rule but as a more soft recommendation. And also more in the mindset of “max 6 trades per quartal” than “max 2 trade per month”. And in each quaterly comment you analyse how good you fared with these recommendation.
It is good to have a thoughtfully eveloped mind- and ruleset, that instinctively restricts your “fast thinking”-decisions but one should take care that it will not restrict the own flexibility too much.
We Germans like to thoughtfully develop clever rules but it is also said we tend to exagerate it sometimes. 😉
Correction: I was that impressed by your numbers that I calculated them for myself to later integrate my own choices (e.g. 26,375% taxes for Germany or 28% for German taxes including church taxes).
There I had to realize you must have some errors in your calculation.
For your numbers (12% performance p.a. pre taxes, 30% taxes) I got the following after-tax-performances, depending on years per depot turnover:
1 Year: 8,40% (like your numbers)
2 Years: 8.54% (vs. 10,2%)
3 Years: 8.67% (vs. 10,8%)
4 Years: 8.80% (vs. 11.1%)
5 Years: 8.93% (vs. 11.3%)
6 Years: 9.05% (vs. 11,4%)
7 Years: 9.16% (vs. 11.5%)
8 Years: 9.28% (vs. 11.6%)
30 Years: 10.73%
Never: 12.00% (as your numbers).
So the penalty for early selling and the reward for holding several years is much ways smaller than it looked at first sight, so they offer much less evidence for a change of strategy.
PS: Your headline misses an t: Srategy
Roger,
one explanation for the difference could be that I didn#t use an “exit tax”. So 12% compounded over 30 years is obviously 12% p.a. I think this is more realistic as you don’ just sell everything after 30 years.
mmi
I recalculated it with the special rule of not calculation a final tax evenif it would be up to time rolling it (what is logically incorrect in my opinion if you simulate with a portfolio rolling and taxing every 3,4 5 oder 6 years but not the last time it regularly had to be rolled). The numbers changed a bit but they are still far away of yours:
1 Year: 8,40% – 8,75% rec. (vs. 8,40%)
2 Years: 8.54% – 8,99% rec. (vs. 10,2%)
3 Years: 8.67% – 9,21% rec. (vs. 10,8%)
4 Years: 8.80% – 9,42% rec. (vs. 11.1%)
5 Years: 8.93% – 9,62% rec. (vs. 11.3%)
6 Years: 9.05% – 9,80% rec. (vs. 11,4%)
7 Years: 9.16% – 9,54& rec. (vs. 11.5%) (spike due to last taxation in Y 28 and next regular tax. in Y 35)
8 Years: 9.28% – 9,97% rec. (vs. 11.6%) (smaller spike due to last tax. in Y 24 and next regular tax. in Y 32)
30 Years: 10.73% – 12% rec.
Never: 12.00% (as your numbers).
I am sorry but I seriously doubt your numbers. If they are relevant for you and your investment strategy (as your article suggests) I would suggest to revisit your calculation.
At least for me it would be quite annoying to change my investment habits due to an important insight from a calculation and later having to recognise that calculation was obviously wrong.
Just to be clear i always used the tax when there is a roll, so in the 5 and 6 year cases there is of course a tax payment in year 30. The 30 years is just a simple cut off, nothing els.
Dear Roger, as I was sick the last two days I could not check my Spreadsheet. So here is for instance the detailed calculation for turning the portfolio every 2 Years:
In this case I simply compounded the starting value of 100 every year alternatively by 12% and 8,4%. In order to come up with an annual compounded growth rate, I simply use the formula (((final value)/(initial Value))^(1/30))-1 which is the standard formula.
I honestly have no idea how you came up with your numbers. For some reason your results look “linear” which makes no sense when you look at compounded rates as compounding always works exponentially. Which is why some people call it the 8th world wonder….
mmi
I see that Chiru already showed how to calculate the average annual return.
I can even shorten the formula in a mathematical term: For your specifications, 12% return per year, 30% finance tax and a total depot all Z years, the annual return after tax can be calculated as (1 + (1,12^Z – 1)*(1 – 30%))^(1/Z) – 1
There is no need to use a limit of 30 years as the maximal return is already achieved after Z years,
To make the formula even more flexible to the change of specifications: For a pre-tax-return of X%, a financial taxation of Y% and a depot turnover all Z years the average annual performance can be calculated as (1 + (1+X%)^Z – 1)*(1 – Y%))^(1/Z) – 1.
I am glad the 8th world wonder was that easy to discover. 😉
Although this does not change the essence of the argument. In contrast, the holding period should be even longer. “Forever” as “Big W.” would say.
The advantages of longer holding an investment are smaller than first assumed.
And some disadvantages remain:
“– Many investments may be good in a short period, but not that good in the long period.
That should work for many “opportunity” investments, but as well for many deep valued cigar butt style investments.
Additionally many companies tend to slow their performance by getting older and bigger as it can be seen even at Berkshire Heathaway.”
But you are still correct, longer investments offer more value for the same performance than shorter investments.
Well to be precise: The advantage of selling never against yearly is still the same, but you are right, it takes longer longer to gain a higher share of the advantage.
Good Point.
I have written about this topic on my blog too.
http://undervaluedjapan.blogspot.de/2015/02/value-investing-and-virtue-of-being-lazy.html
http://undervaluedjapan.blogspot.de/2014/03/value-investing-and-art-of-doing-nothing.html
I have to say that I do not think that one can force oneself or learn to switch positions less frequently. It is a questiion of mentality. It is extremely difficult to kick bad habits. I even would go further and argue holding on to positions for extended periods of times is one aspect of the “art part” of value investing.