Jim Collins shares an interesting counter-intuitive insight in his best-selling book ‘Good to Great’ which he refers to as ‘The Stockdale Paradox’. It is named after Admiral James Stockdale, one of the most decorated US Navy officers who was also awarded the Medal of Honor in the Vietnam War.
As a prisoner of war in Vietnam for 8 years from 1965 to 1973, Stockdale was tortured more than 20 times, had no prisoner rights, no set release date, and no There was no certainty whether he would live to see his family again. Despite all this ordeal, he survived, while many of his fellow prisoners did not survive. How did he survive?
That’s exactly what Collins asks Stockdale. “I never lost faith at the end of the story. I doubted not only that I would pass out, but also that I would win in the end and turn the experience into the defining event of my life, which, in retrospect, I I will not trade.”
Taking a few minutes to reflect, Collins further probed “Who didn’t make it?”. Stockdale’s unexpected response was – “Oh, that’s easy. Optimistic!”. But didn’t he just say that you need to have faith at the end of the story. Don’t optimists think so? Here’s how Stockdale explains this underlying contradiction. “Optimists. Oh, they were the ones who said, ‘We’re going out until Christmas.’ And Christmas would come, and Christmas would go. Then they used to say, ‘We’re going out until Easter.’ And Easter would come, and Easter would go. And then Thanksgiving, and then it would be Christmas again. And they died of a broken heart.” Then he shares a simple yet profound advice. “This is a very important lesson. You should never confuse the belief that you will win in the end – which you can never tolerate. Lose – with the discipline to face the most brutal facts of your current reality, whatever they may be.”
What a powerful lesson. While Stockdale had nothing to do with investing, that’s exactly the ‘mindset’ we all need to adopt as investors.
Your ability to cling to equity over the long term ultimately depends on your belief that human progress, ingenuity and entrepreneurship will prevail in the end, despite all inevitable temporary setbacks. The recent invention of COVID vaccines in record time is a humble reminder of our ability to overcome setbacks. We are only betting that overall good entrepreneurs will be rewarded with higher returns in the long run.
Justifying the confidence, patient Indian equity investors have historically been rewarded with large long-term returns that closely reflect the underlying earnings growth of companies.
Therefore, the first major behavioral component required for long-term equity investment is ‘trust in equity’.
However, in the short term, the Indian equity markets have experienced a temporary decline of 10-20% almost every year. Once every 7-10 years, there is a large temporary drop of around 30-60% such as the covid crisis in 2020, the global financial crisis in 2008, the tech bubble in 2000, etc.
Most investors who have tried to avoid the pain of a short-term downtrend by trying to time the market have ended up with subpar returns because they usually stay out too long in fear and miss the upside.
A better approach is to simply accept the inevitable fallout rather than foresee it and view it as an ’emotional fee’ to be paid for reasonable long-term returns.
As veteran investor Peter Lynch puts it, “far more money has been lost by investors trying to prepare for a correction, or hoping for a correction, than it has been lost to the reforms themselves.”
This brings us to the second key behavioral component required for long-term investing – ‘the ability to suffer in the short term’.
As investors, we need to accept both realistic pessimism about the short term and practical optimism about the long term.
This will mean creating enough “room for error” through diversification (across asset classes, investment styles, sectors and geographies) to survive in the short term, while our long-term belief in entrepreneurs will keep us patiently sticking to our plan in the long run. Will help you survive. To benefit from the magic of compounding.
Wise long-term investing ultimately boils down to the subtle art of balancing these two conflicting mindsets:
1. Confidence in Equity over the Long Term
2. Ability to suffer in the short term
In other words, as the Stockdale Paradox reminds us – “Have faith but face reality.”
FundsIndia Head of Research Arun Kumar R.
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