Successful investing requires intelligent analysis of both short-term and long-term factors. While long-term factors are typically much more important, it’s the short-term ones that dominate news media stories—so don’t hold your breath waiting for headlines regarding long-term productivity trends. Many years ago, before I became a professional investor, I developed a simplistic “stream theory” to help explain some aspects of long-term investing to my students. To illustrate this line of reasoning, picture yourself in a canoe paddling downstream, and suppose that your destination is many miles away. Suppose further that over the course of your canoe trip the average stream velocity is four miles per hour, with faster speeds over steeper stretches of the stream and slower speeds along flatter terrains. In the context of this canoeing example, the average stream velocity is a long-term factor. That is, stream velocity—and your average paddling rate—will largely determine how long your journey will take. On the other hand, the locations and durations of steep and flat terrain amount to short-term factors—sometimes exciting and sometimes not. Anyone who extrapolates these short-term occurrences is likely to risk misjudging the overall journey. As investors, we need to focus on long-term factors—not last month’s or last year’s news—and consciously place ourselves in investment streams that have the requisite average velocity to get us to our financial destinations within our investment time horizons. For example, stock streams typically flow faster than fixed-income streams over the long term. Within the stock category, there are important quantitative factors (like low price/earnings ratios) and qualitative factors (like industry dynamics) that affect stream velocity for specific stocks or groups of stocks.
Aug 2016