Investing is not just the study of finance. It’s the study of how people behave with money.

    You can learn a lot about investing by studying the behavioral skills of how people react to risk in disciplines that have nothing to do with investing.

    A few years ago I got to listen to a speech by one of the US Navy SEALs who took part in the raid that killed Osama Bin Laden.

    He said: “One of the key lessons learned early on in a SEAL’s career was the ability to be comfortable being uncomfortable.”

    Being cold, wet, hungry and exhausted becomes a normal and unavoidable part of a soldier's life. Accepting and dealing with discomfort takes precedence over escaping it.

    SEALs are in their own league of dealing with discomfort. But that idea - learning to be comfortable being uncomfortable when discomfort is a reality of getting the job done - is one that most of us can gain from.

    Endurance while uncomfortable is one of the most underrated and overlooked skills.

    This is true of investing, and especially as we look ahead to 2020, with a global economy looking increasingly precarious.

    The agony and the ecstasy

    This chart shows an all-stock index of UK equities going back to 1955, calculated by Dimensional Funds. The returns are, frankly, sensational. One dollar turns into $1,267, including dividends:

    Morgan chart 1
    Source: Dimensional Funds

    This is the reward - a combination of capitalism and compounding at work. This is why we’re all investors.

    But what’s fascinating about this period is how agonizing it was for investors.

    This is the same UK stock data shown a different way, highlighting volatility relative to the previous all-time high:

    Morgan chart 2

    During this period when UK stocks turned every dollar into more than $1,200, the market was 10 per cent or more below its previous all-time high in 28.6 per cent of all months. It was 20 per cent or more below the previous high in 12.2 per cent of months.

    It’s a mess. Pure chaos.

    At every point of decline in this chart there were undoubtedly millions of investors opening their account statements saying: “This doesn’t feel right. It’s uncomfortable. And I don’t want to be uncomfortable ... so I want out.”

    And so they sell, to their own detriment and at the cost of long-term returns.

    Most investors expect volatility. But the amount of volatility that can take place within the context of otherwise extraordinary returns is easy to overlook.

    And this applies to more than broad indexes. It affects active investors just as much, if not more.

    Investment firm Research Affiliates once looked at the top three best-performing US equity funds from 1970 to 2014. Each outperformed its benchmark by more than 2 percentage points a year - which, over 44 years, is extraordinary.

    A common attribute of each winning fund was the percentage of its lifetime it spent underperforming its benchmark, that is a third of the time or more.


    Excess annual return Over S&P 500, 1970-2014

    Per cent of quarters spent underperforming 

    Longest consecutive quarterly underperformance streak 

    Franklin Templeton Mutual Share 




    Fidelity Magellan 




    Fidelity Contrafund 




    In this case we’re cherry-picking the top funds over an excellent period. And yet we still come up with a period that, for the average investor, was miserable: underperforming a third of the time, often for many consecutive years.

    Go down the list of other famous investors, and that pattern re-emerges.

    Warren Buffett’s Berkshire Hathaway has compounded at 20.04 per cent annually for the last 38 years. But it’s spent one day in six at 20 per cent or more below its previous all-time high.

    His partner Charlie Munger ran a wildly successful hedge fund in the 1960s and 1970s. Over 13 years it outperformed by more than 900 percentage points. But it also underperformed the market in five of those years, two of which were 30 per cent corrections. 

    Now, discussing how common volatility has been is one thing. Understanding why it’s worth enduring and putting up with - being comfortable being uncomfortable - versus agonizing over it, is something different.

    The price to pay

    We live in a 'tail-driven' world. What I mean is, a few things account for the majority of results.

    US stocks have driven the majority of global stock returns over the last decade. And fewer than 10 companies in the S&P 500 consistently account for the majority of the index’s return.

    This is true across the globe in every major market. 

    In the US, Amazon alone drove 6.1 per cent of the S&P 500’s returns last year.

    Amazon’s growth is almost entirely due to Prime and its cloud computing platform Amazon Web Services.

    These themselves are tail events inside a company that has launched hundreds of products, from the Fire phone to travel agencies.

    Two years ago, Apple alone was responsible for more of the index’s total returns than the bottom 321 companies combined.

    That’s a huge tail-driven result. And yet Apple’s success is owed overwhelmingly to one product out of the dozens its experimented with: the iPhone.

    Warren Buffett is the greatest investor of all time, and he too is a tail investor. He once said he’s owned 400 to 500 stocks during his life and made most of his money on 10 of them. 

    A corollary to a tail-driven world is that even within successful systems, a lot of individual components don’t work out. The trick, and my message for you and your clients today, is coming to terms with that reality.

    Scott Adams, the Dilbert comic creator, has great advice: “If you want success, figure out the price, then pay it. It sounds trivial and obvious, but if you unpack the idea it has extraordinary power.”

    An important but overlooked 'price' to pay in investing is a willingness to put up with uncertainty.

    It’s becoming comfortable with the idea that during a small percentage of the time a small percentage of your investments will drive most of your overall returns.

    What happens the rest of the time - discomfort from volatility and stagnation - is a normal part of a successful long-term story.

    You don’t pay that price in currency, and its amount is never advertised. It’s paid with stress hormones, doubt, and worry. But it’s a real cost.

    The reason it’s generally worth paying is because not all investors view it as a cost. They view it as a fine, like something to avoid.

    Since not all investors are willing to pay this price, there can be value and reward for those who are willing.

    The key attribute here is your ability to endure.

    I often think back to 2009, when the financial world seemed to be falling apart. A journalist asked Charlie Munger how concerned he was that the Berkshire Hathaway stock had just fallen by 50 per cent. He responded:

    "Zero. This is the third time that Warren and I have seen our holdings in Berkshire Hathaway go down, top tick to bottom tick, by 50 per cent.

    "In fact, you can argue that if you're not willing to react with equanimity to a market price decline of 50 per cent two or three times a century you're not fit to be a common shareholder, and you deserve the mediocre result you're going to get compared to the people who do have the temperament and who can be more philosophical about these market fluctuations."

    That is comfortable being uncomfortable.

    As the global economy looks increasingly unstable, it’s a wonderful lesson to remember.


    Morgan Housel was a speaker at the Nucleus annual conference 2019

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