Investing Isn't for the Faint of Heart

05/08/2013 9:00 am EST

Focus: STRATEGIES

Michael Cintolo

Vice President of Investments and Chief Analyst, Cabot Heritage Corporation

While market averages are important, the real key to successful investing is sticking with it and benefiting from the occasional big winner, says Michael Cintolo of Cabot Wealth Advisory.

The real key to successful investing is the perspective that today, tomorrow, even this week is just a tiny piece of the overall pie of life that helps us through some of the tough times. However, that perspective seems to vanish when investors are buying individual stocks.

Sure, if you’re steadily putting money into a 401(k) plan, it’s easier to think of the long term. The money isn’t touchable until you’re in your 60s, and we’ve all been “taught” to stick with our mutual funds for the long- term.

But when you’re an active manager of your own account, it’s common to live and die with every trade. Every big move by a stock or the market seems larger than life. A bad week can mess with your head, and a bad month or two can convince many investors that they don’t have what it takes!

But I really try to think of every trade I make as just one of, say, 1,000 I’ll make over many years. Those 1,000 trades will surely include some winners, some losers, some earnings gaps up, some earnings gaps down, some bad markets, some incredible bull markets, some perfect buys (when the stock goes up right after you click the buy button), and some awful buys (where the stock plunges once you’re in).

When you think this way, it makes it easier to stick with a time-tested system, take things “inch by inch,” and not sweat the small stuff—i.e., the occasional 15% loss or a stinker of a week. And that, ironically, will lead to better performance over time, and fewer down times.

Investing in stocks is really a game of outliers. If you organize your trades from biggest winner to biggest loser, you’ll see that the middle 60% or 70% of trades will probably cancel each other out. It’s the big losers and big winners that make the difference.

The S&P 500 has averaged gains of 9.85% per year (including dividends) since 1926. Thus, when looking at the year-by-year returns, it would make sense that most would be clustered around that 10% figure, say between 5% and 15%. Makes sense, right?

Well, reality is completely different. Of the S&P’s 86 years (through 2012), the market has actually produced an outright loss in 24 of those years, or just about 28% of the time—more than one year out of four.

Conversely, the market has returned at least 20% in 32 years, or just about 37% of the time—more than one year out of three. It turns out the market has delivered a return of between 0% and 20% in 31 different years...just 36% of the time.

To put this into a broad context: Even though the market returns an average of 10% per year since 1926, only one-third of those years returned anywhere between 0% and 20%. The other two-thirds of the time, the market either gained more than 20%, or lost ground completely!

It turns out that “unexpected” moves happen much more than they are “supposed to,” but it’s exactly these kind of moves that will determine your results.

Once you embrace this concept, it can actually prove quite liberating. After all, if you grind it out for two or three months without making any progress, it’s no big deal, because all you need to do is find one or two bigger winners to make all the difference. You don’t have to be right every time.

Every trade is important, but you shouldn’t stress over every decision, because a few big winners over a couple of years will make all the difference

Related Articles:

5 Steps to Disciplined and More Profitable Investing

6 Common Investing Mistakes to Avoid

Do You Need More Luck, or Skill?

Related Articles on STRATEGIES