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  • Brett Schafer

Being Biased to the Long-Term

This is the third post in a series I am calling “Investing for the Long Term”. You can read the second post here and the first post here.

“Someone’s sitting in the shade today because someone planted a tree a long time ago.”- Warren Buffett

Humans, at least generally, struggle with being patient. I think I speak for most of us when I say two-day shipping and on-demand taxis are now expected, not wanted. Our instant gratification society is conditioning us to demand immediate results, rush the process, and not let things take their proper time.

This way of thinking can and will bring about many negative repercussions, especially in the world of investing. Day trading, a phenomenon historically reserved for professional investors, took off like wildfire with the rise of internet brokerages in the ’90s. The nearly instant process of buying stocks online gave people the opportunity to fall for their worst instincts and trade in a way that usually underperforms the broad market (and with a hell-of-a-lot more work).

The Hype Cycle

Another way our modern society negatively impacts investors is the expectation that the future will be here tomorrow. Over the last thirty years, we have seen quite a bit of this phenomenon. It is called the hype cycle and is one of the underlying principles of bubble creation.

Remind you of anything? If not, here are some charts that might spark some (hopefully not bad) memories:

The most common example of the hype cycle is the internet bubble of the late ’90s. Everyone thought the internet was going to change the world. It eventually did, just not as fast as investors predicted. Big tech dominates the market in 2019, making investors who stayed patient very, very rich.

Some current trends that are at different stages of the hype cycle include blockchain, cannabis, A.I., and self-driving cars. All four have fallen victim to media-induced fantasies that their ubiquity is right around the corner. Will these technologies ex-cannabis sooner-or-later change the world? Probably. But do we know for certain the time-frame that this will occur? Definitely not.

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Our Evolutionary Programming

The path of human history has led scientists and historians to conclude we evolved with the short-term in mind. For the majority of our time on earth, homo sapiens has dealt with a life that revolved around getting the next meal, fending off predator attacks, and finding shelter.

Here are some tremendous quotes from an article in the Inspired Economist about how our brains are hardwired to worry about short-term events:

This pattern reveals a fundamental characteristic of how our brains work; we tend to focus on the short term, and have little thought of the long-term consequences of our actions. The early hunters devised ever more efficient ways of killing the existing inhabitants of the new lands they occupied. There was no thought of long-term consequences.

Our brains have evolved to react to short-term crises, such as an attack by a hungry lion. The more subtle cognitive abilities which would allow us to assess and respond appropriately to longer-term threats are much less developed within the human brain.

Modern society is quite a bit different than the African Savannah our species evolved on. Individual emergencies that threaten survival happen nowhere near as frequently, and while this is definitely a good thing, it is absolutely not what our bodies are built to experience. Our instincts hold us back from solving long-term problems until crises occur, which has held us back when trying to solve slow-moving issues like climate change.

But how can we apply this to investing? The first thing is to understand everyone is instinctively biased to the short-term and will be emotionally inclined to overreact to recent news. Most of us will anchor our predictions and think the last five years will just repeat into the future indefinitely. Investors need to understand these biases and emphasize patience and objectivity.

The Future is Still Never Certain

Making specific predictions on a ten-plus year time-frame is not only foolish but likely harmful to investing returns. In 2007 nobody could have confidently predicted Netflix was going to dominate the media industry and turn cable television on its head, or that taxi cabs would be obsolete in twelve years because of an app. This is not the long-term predictive thinking that should concern investors.

What I believe investors should analyze is the next 2-5 years, at least when evaluating the potential of an individual stock. Short-term news and price action should be ignored unless it changes the stock’s probability of success.

Spotify, a stock I own and am bullish on, can be thought of this way. It is likely that in 3-5 years Spotify will have over 400 million users, a range of original podcasts, and better deals with the music labels. For these reasons, I believe the stock is undervalued at the moment and presents a great opportunity for market out-performance. But can I say with any conviction that Spotify will still be a market leader in 10-12 years? Hell no.

For anything over 10 years, it is best to think in trends and not specifics. Here are some trends I think have a high likelihood to continue over the next 25 years:

  1. The world becomes more digital and app-based

  2. Video and audio being streamed digitally

  3. The U.S. will still be the best country to invest and invest in

  4. The warming of the climate

  5. The rise of eSports

None of these trends involve specific companies. However, investors can and should keep these trends in mind when evaluating an individual stock as a potential company to own.

It is important for people to understand their brain wants to overreact to the short-term, while still accepting the future is and will continue to be ambiguous. We should try and be biased to the long-term while being certain of uncertainty.

Disclosure: The author is not a financial adviser, and may have an interest in the companies discussed.

#Bias #evolution #Investing #Longterm

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Listen On: Spotify Apple Podcasts Disclosure: The author and podcast guests are not your financial advisors. Ryan Henderson and Brett Schafer are general partners and portfolio managers at Arch Capita

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