Monday, 23 May 2011

Patience and the Art of Income Investing

Patience is a virtue, they say. Anyway, I'm pretty sure that without patience you cannot be a good investor.

A recent article in Scotland on Sunday has highlighted the importance of patience for savvy consumers. It reported - encouragingly - that, according to a poll commissioned by Standard Life, only one in eight of us would choose the instant gratification of a £640 holiday this year, rather than wait five years for a holiday worth £5,000.

Experiments with young children show that we learn to be patient at about 3 to 4 years old. This is the age when, for example, a child can be presented with the following deal: "here's a cookie; if you can wait 5 minutes without eating it, I'll give you two cookies!"

So we all learn the basic principle pretty early on: sometimes it is better not to take a reward straightaway but rather to delay receiving the reward and hopefully let it grow: delayed but amplified gratification.

Saving is another form of this delayed gratification. Not spending money on something today will mean that you have more money to spend tomorrow - or next year. So saving is a manifestation of patience - the ability to sit and watch your money grow without spending it; the ability to delay consumption.

There are degrees of patience, of course - and it would be great to be able to pass on this virtue to all kids. Some of them get it straightaway and, sadly, others just don't. Some kids seem to be able to save money and some just have to spend it as soon as they get it. This is where parents need to help out by setting a good example - and by enforcing a little 'patient' behaviour on their kids, like an obligatory savings rule for kids (e.g. taking a little of their birthday and holiday gifts and putting them somewhere safe where it can multiply). This is one of the greatest gifts that parents can give their children - the ability to be patient, to not consume but to save.

Sadly, today it is harder than ever to encourage patience in consumption. Why should anyone wait to get something they want if cheap (and frequently not-so-cheap) credit is offered by almost every retail outlet? "No money down and 2 years' free credit" is all-too familiar - and enticing! Kids are offered credit cards on the basis of little or no income or savings.

Older people remember when it was different - if you wanted something, you saved for it. Strangely, having the discipline (or patience) to delay a purchase (say, by a week) seems to make the 'object of desire' a lot less attractive - there is something emotional about the act of purchase that destabilises our other - more sensible - instincts.

Debt is the antithesis of patience - with the exception of debt taken on for really big purchases, such as a mortgage for a house or, possibly, a loan for an automobile (although I paid cash for my last two vehicles). And the curse of debt is the interest payment, which can easily balloon out of control and crush the spirit of any individual or family. Once sunk in debt people start to lose hope of ever re-surfacing financially. But, of course they can - if they re-learn the art of 'patient consumption'.

Assuming you have debt under control (which means no debt, as far as I am concerned) you can turn you attention to growing your wealth. The key is simple - spend less than you earn; in other words, continued to practice patience in consumption. Some people (and families) can be so adept at this that they can live on less than half their income.

Once you are generating spare cash, and have an emergency fund to cover unexpected expenses, you can begin to invest in asset classes that will increase your wealth over the medium to long term. And in investing patience is also a key virtue; you are not investing for the short term and (by now) you will have realized that you are unlikely to 'get rich quick'.

Buying and selling investments (such as shares and bonds) incurs costs and fees, - meaning that the more you 'chop and change' your portfolio, the more it will cost you - and the less your investment fund will increase in value. So the patient investor will aim to 'buy and hold'. This will mean not selling immediately your holding increases or falls by 10 or 20% in value but taking a longer term view on the likely future for your investment. In the 2008 stock market crash, if you had sold out you would have lost a substantial amount of capital; if you stayed invested you would be almost back to the pre-Crash level of value.

Finally, I believe, for the patient investor an 'income' bias to their investment strategy will be more satisfying. Inherently this approach is a 'get rich slow' strategy, with much less emphasis on 'value' strategies (with their subtle promise of getting rich quickly) and more on slower, but more reliable investments:
  • high-yield money market accounts, particularly those that tie up your money for years, but offer good rates of interest
  • high-yield dividends from companies that are likely to continue paying and increasing
  • high yield corporate or government bonds
  • minimizing exposure to tax (a lot of patience is required here).

And the reward of patience is to sit back and enjoy (for many years, hopefully) the fruits of economy and wise investment - and of course to pass on the lesson to the next generation.

Article first published as Patience and the Art of Investing on Technorati.

I am not a financial advisor and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.

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