Investing for long-term outcomes: macro economic factors and the “chessboard problem”
Investment outcomes associated with short term returns (cyclical) and long-term returns (compounding) are nowhere near even. Despite alpha from compounding being higher, more enduring, and less volatile, investing in highly cyclical companies for mean reverting returns has great appeal for reasons of instant gratification (a strong psychological force). Since returns from compounding are non-linear, that is, do not go up in a straight line, investors surmise that a bird in hand (cyclical, mean reverting returns) is better than two in the bush (compounding). Investment markets always pose the following question to investors, “would you rather take $1m right upfront or a penny on day one doubled every day until day 30?”. Doubling every day for 30 days would yield $10m while doubling every day would yield $1m in 27 days. So, taking $1m upfront would make you look like a hero for 27 days. However, you would rue your lack of patience to net you $10m in the last three days of the month. That’s why temperament has an exponential impact on investment outcomes (relative to other sources of alpha generation, namely, analytical, and informational advantages). Temperament allows us to forgo upfront gains (quarterly and even annual gains) in favor of compounding outcomes that may only show up further out on the horizon of transient factors affecting the economy/industries.