Why practice doesn’t make perfect in investing

Prudent strategies often look like errors in the short to medium term

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In almost everything we do—whether it’s learning the violin, playing chess or excelling in sports—practice makes us better. In his bestselling book Outliers, Malcolm Gladwell popularized the “10,000 hour rule.” It says no matter how talented one might be, becoming a virtuoso musician, a chess grandmaster, or an elite athlete typically requires approximately 10,000 hours of practice.

Even more important, you need to receive useful feedback during your practice. In Thinking Fast and Slow, the psychologist Daniel Kahneman explains that learning to drive is one activity where feedback is immediate and clear. When you’re taking curves, you instantly know whether you’ve turned the wheel too sharply or applied the brakes too hard. This makes it relatively easy to improve as a driver. By contrast, a harbour pilot learning to guide large ships experiences a longer delay between his actions and their outcomes, so the skill is harder to acquire.

Now consider how these ideas apply to investing. Someone who has little experience is likely to make many mistakes—which is normal in any new activity. They might think they’re well diversified even if they own just five Canadian stocks, or they may choose a bond based solely on its yield, without considering the risk. They might trade frequently based on what they see on BNN, or hold inappropriate investments in taxable accounts rather than using proper asset location. These errors would all be easy enough to correct. But will the investor get immediate and clear feedback about them?

In many cases, there’s no feedback at all: if you pay too much in taxes or hidden fees because of poor investment choices, how would you ever know that? True, sometimes the feedback is immediate: a stock could soar or plummet in value within days of purchase. But since investing is a long-term process, real success is impossible to measure over periods of even a few years. An adviser I know likes to use a golf analogy: imagine hitting a shot from the tee and not knowing where the ball landed for five years.

Nice guys can finish last

Moreover, the feedback you get from investing is rarely clear. On the contrary, prudent strategies often look like errors in the short to medium term, while many bone-headed moves are rewarded with outstanding returns, at least for a while. This is what Larry Swedroe calls confusing strategy with outcome.

Imagine two investors in the first weeks of the 2008 financial crisis: one stayed disciplined while the other sold everything and moved to gold. Over the next six months or so, the market would have made the balanced investor feel like a moron while giving bragging rights to the gold bug. But did that feedback provide useful information to help these investors improve their decisions in the future? Or did it do the opposite?

So if the feedback you get from the markets is slow and unreliable, what’s an investor to do? I suggest changing your approach to “practicing.” Unless you’re a day trader, you can’t improve your knowledge and skill as an investor by buying and selling investments and evaluating the results over short periods. Instead, why not spend your time and effort learning about what you can control?

Start by deepening your understanding of risk: novice investors often underestimate the potential losses they can suffer in the stock market. (A rule of thumb: Assume your stock holdings can lose half their value.) Build your technical knowledge by learning how bond math works, or how dividends are taxed, or how to properly calculate your rate of return. And the most important insight of all? Learn about the most common behavioural mistakes and how to avoid them. Unless you get that part right, no amount of practice will help.

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