The Globe and Mail, Report on Business
Published September 18, 2010

Every summer Lori and I make a pilgrimage to the famous Highland Cinema in Kinmount, Ont. This summer’s movie was Inception. While I had mixed feelings about the film (movie – 2 stars; conversation after – 4 stars), I found the premise of being able to implant ideas in people’s brains to be intriguing. So in subsequent weeks, I’ve been asking the investment pros I meet with to play Leonardo DiCaprio’s role. If they could implant one idea, concept or skill to help investors generate higher returns, what would it be?

The mind altering suggestions I got fit into three general themes.

Implant No. 1: Make judgments based on longer-term information.

There’s a real frustration with how short term investors’ focus has become. Investing is an endeavour we do to offset long-term liabilities (i.e. provide a paycheque in retirement). And yet we’re wired for instant feedback. The dialogue, strategies and reporting are all focused on what’s happening now. In a world where patience is defined by the 24 hours it takes to get the results for Dancing with the Stars, waiting a few years to see whether a fund is going to perform or a strategy will play out seems out of the question.

The frustration comes from the fact that, in the world of investing, short-term price moves are totally random, and judgments based on it have little impact on long-term value creation. Rather, returns come from letting the power of compounding do its magic over time.

I must admit that I didn’t expect to hear professionals who are managing billions of dollars saying: “Get started early, have a long-term plan and stick to it.” It’s hard to believe we need to implant something so basic in our brains.

Implant No. 2: The stock market does not equal the economy.

People tend to expect the market indexes to reflect what’s going on in the economy, but the fact is that when this alignment occurs, it’s a total fluke. That’s because the market is continually looking forward, having long since absorbed the current situation. It doesn’t always predict the future correctly – I remember Paul Samuelson, the Nobel laureate economist, saying that the stock market predicted nine of the last four recessions – but it’s always trying.

This disconnect constantly confuses investors, amateur and professional alike. Shouldn’t the market ultimately reflect what’s going on in the economy? Yes, ultimately. But it’s a sloppy, unpredictable relationship.

Along with the time frame issue, there is the volatile linkage between the economy and the market, namely valuation. What the market is willing to pay for corporate profits will vary with interest rates, investor sentiment and a variety of other factors.

So even if we get the economy right, we can be totally wrong on our market call. For instance, those who predicted in the fall of 2008 that there was a recession ahead were absolutely right, but if they weren’t fully invested in 2009, they left a lot of money on the table.

As one of the portfolio managers said to me, “People have to stop trying to figure what the economy and market are going to do and start buying good companies.” We’ve made investing as complicated as Inception, but unfortunately we don’t have whiz kid Ellen Page (woefully miscast) to save us.

Implant No. 3: Stop running with the herd

It’s important for investors to realize that if they’re applying the investment basics correctly, they’ll sometimes be out of sync with a majority of the people around them. That’s because the crowd is chasing past performance, buying flavour-of-the-month products and/or trading too much. And because of that, their results are poor. We might take comfort from being with the crowd, but we don’t want their returns.

A consultant I spoke to had a simple strategy for fighting the herd mentality – find a good manager and hire them when they’re at the bottom of the industry rankings, when everyone else is ignoring them.

Similarly, at market extremes when investors are wallowing in negativity, it’s important to realize that poor “past” returns lead to better “future” returns (and vice versa). At such times when markets are fertile, planting seeds for the next cycle makes sense, but it’s guaranteed to be a solitary pastime.

One executive gave me a line (which he credited to Hall of Fame oil man Jim Gray) that sums up what I heard from a number of people: “If you’re getting a warm feeling about what you’re doing, it’s probably because you’re in the middle of the herd.”

Do we need Leonardo dodging bullets and dealing with his inner demons to help us lengthen our time frame, look beyond what’s going on in the economy and prepare to be lonely? Well yes, we all need a little rewiring.