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marshmallows

Avoiding temptation

18 August 2015

Hugh Young of Aberdeen Asset Management explains why investors should resist short-term temptations and think long term.

American academic Walter Mischel conducted one of the most famous experiments in the history of psychology back in the 1960s. Nursery school children were each given a choice; they could have a reward immediately (marshmallows were popular) or, if they waited alone in the room for a few minutes, they could eventually have two treats when a researcher returned.

What would later become known as the ‘marshmallow test’ showed that many children couldn’t resist the temptation of instant gratification (a sweet was left in the room with the child), even though they knew that delaying that gratification would lead to an even bigger reward.

The results also illustrate two common manifestations of the human tendency towards short-termism. One is excessive discounting of the future in favour of the present; the other is an innate bias towards action (young children, and many grown-ups, can’t sit still and do nothing even when it is advantageous to do so).

We have seen this play out over and over again in the financial world: the rise of so-called ‘high-frequency trading’; investors who seek profit from churning portfolios; chief executives who favour quick-fixes that can translate into immediate share gains. That’s because long-termism – making decisions with a view to long-term objectives or consequences – is hard. It takes self-control to decline a tasty snack or to save for a rainy day, especially when it’s clear there’s no immediate payoff.

Forever favourites

Warren Buffett, one of the world’s most successful stock pickers, may be the best advocate for long-termism in the investment world. In the 1988 edition of his annual letter to Berkshire Hathaway shareholders, Buffett wrote: ‘When we own portions of outstanding businesses with outstanding managements, our favourite holding period is forever.’

Investors who have been around a while will know that share prices can be affected by many things over the short term – emotion, the amount of money within the financial system, the supply of securities, acts of god. We can never say with absolute certainty what will happen in the financial markets tomorrow, next week or next month.

However, we’re pretty certain that share price performance over the long term can only be supported by sustainable earnings growth, especially when that performance is measured over decades.

All good companies (and even some bad ones) will have a long-term perspective. It therefore makes sense to align our investment horizon with those of the companies in which we seek to invest.

Instead of worrying about short-term price movements, or the temporary gain or loss of capital, we’re far more concerned about the possibility of a permanent loss of capital, which is all about assessing a company’s long-term business prospects.

Tall order

Therefore, long-termism lies at the heart of our investment thinking. Our idea of the perfect company is one whose shares you never need to sell because earnings will rise 10 per cent to 15 per cent every year and where the share price accurately reflects this growth.

While perfection may be a tall order, we have been shareholders of some companies for many years. For example, we started investing in Singapore-based OCBC Bank around 20 years ago. Our investment, including dividends, has returned more than 530 per cent since end-May 1996.

When researchers conducted follow-up studies of the original marshmallow test subjects some two decades later, they found that those children who managed to delay gratification the longest had gone on to do better at school, secured better jobs and made more money.

Intuitively this makes complete sense to us.

Success in life, like investing, requires many qualities. But conviction and discipline must rank near the top. Whether we’re talking about getting an additional sweet or building a nest egg in a sustainable manner, it pays to think long term.

Hugh Young of Aberdeen Asset Management is the manager of the St. James’s Place Far East fund. The opinions expressed are those of Hugh Young and are subject to market or economic changes. This material is not a recommendation, or intended to be relied upon as a forecast, research or advice. The views are not necessarily shared by other investment managers or St. James’s Place Wealth Management.

The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.

Some of the products and investment structures documented within this article will not be available to our clients in Asia. For information on the funds that are available please get in touch.

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