John Maynard Keynes was a 20th century economist, best known for advancing the use of budget deficits and surpluses to smooth out economic busts and booms.
He also left a nugget of gold for investors – the metaphor of ‘animal spirits’.
“Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits – a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.”
An investor who can internalise Keynes’ message will be infinitely better protected from the market’s emotions – and their own.
Most people are born optimists. I certainly am. As a species, that leaves us much better placed to improve our lives. If we didn’t believe things could be better, fewer of us would try. But we do, and our quest for improvement depends on our ability to see things as they could be – and the belief we can succeed in our quest.
The downside is that investors can easily forget the downside! Optimism leads us to see the bright lights of what could be. Unchecked, that tendency can also lead us into trouble. Keeping your eyes on the prize is vital for success, but failing to notice the pitfalls and obstacles on the path may rob us of exactly what we’re chasing.
Warren Buffett’s famous two rules are:
1. Don’t lose money; and
2. Never forget rule number 1
Like the tortoise, the journey may be slower, and maybe a little less exciting, but losing money means being sent back to the start line to begin again.
Spontaneous Urge to Action
‘Don’t just stand there, do something’ is an exhortation we’ve all heard at some time. Humans don’t like to feel helpless – we like to be in control and doing something… sometimes anything! That makes a lot of sense if you’re in a burning building, or facing an oncoming car.
Unfortunately, this urge can drive investors to make mistakes. Impatience and the feeling that ‘the market’ is moving can be all the stimulus we need to take action. The market moves up, and we feel like we’re missing out, so we buy. The market drops, we get concerned and figure we should sell.
If you don’t believe me, ask investors who sold out during or immediately after the GFC-induced market drop and have only recently re-invested how they feel about missing the rally as a result of this urge.
The Two Certainties of Investing?
The other impacts of this urge to action are the ‘frictional costs’ of investing – brokerage and taxes. Each time you buy and sell, you’re paying brokerage – a small (or not so small) amount of your investing capital is hived off, never to return. Do that over and over again, and you’ll need to add a few percentage points to your desired return just to cover brokerage.
In their excellent book The Millionaire Next Door, Thomas J. Stanley and William D. Danko recount the example of a particular individual who had spent $35,000 in the previous year for advice and brokerage on his $200,000 portfolio. For all we know, the money may have been well spent – but he needed to earn a 17.5% return just to break even – so it had better have been great advice!
Taxes are another killer. Leaving your capital alone to compound delays capital gains tax, and leaves you with more money working for you. Realising taxable gains means more for the government and less for you. I firmly believe – and it’s the law – that we should pay the tax we’re liable for, but in the immortal words of the late Kerry Packer (to a Senate inquiry, no less) in 1991:
“If anybody in this country doesn’t minimise their tax they want their heads read because as a government, I can tell you, you’re not spending it that well that we should be donating extra.”
Now I don’t know too many investors – even the best ones – who will, in John Maynard Keynes’ words, compute the “outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities”, but you don’t need to. A good dose of patience, considered thought and inaction can be a powerful combination.
Do yourself a favour and ignore the animal spirits, both yours and the market’s.
Think deeply, act slowly, invest wisely (and Foolishly), and you’ll do well.