Two children decided to compete to see who could grow the most luxurious garden. Both Peter and Paula prepared the ground, laid down the seeds and watered the soil. Three years later, Peter’s garden had barely grown, while Paula’s flourished.

What was the difference? Peter was impatient. Coming back the next week after planting the seeds he was disappointed there was little movement. He decided to dig it all up and start again. Paula added water and fertiliser and waited.

This cycle continued over the years. Peter decided at one point there was not enough sun, so chopped down an overhanging tree. The soil dried up under the full sun and baked hard. Paula decided to leave well enough alone with her garden.

The difference in approach between these two aspiring gardeners is evident every day in the share market. Many investors, having assembled their portfolios, insist on fiddling. They respond to news, second guess themselves and churn their holdings.

The Peters of the investment world chase past returns, pick up on investment fashions and are impatient for quick results. The Paulas leave their asset to grow, knowing that compounding will do much of their work for them.

Of course, this isn’t to say the second group of investors are totally passive. They come back every six months or so and do some pruning in the form of rebalancing. They water, weed and fertilise the investment garden with new cash as it comes to hand.

But the more successful gardeners are systematic in their approach. They focus on the basic elements and what is within their control. For the most part, they let nature take its course. And they exercise discipline along the way.

This is part of a series of blog posts in which we use illustrative analogies to simplify the often-complex world of investing. Take a look at some of the previous articles below:

Pay less attention to weather forecasts

Why stick with a losing proposition?

Why you should ask the audience

This year marks the 300th anniversary of one of the world's most famous financial catastrophes: the South Sea Bubble. It is a story with complex origins, but the pattern of events in 1720 has unfortunately been repeated in similar ways many times since.

It is not necessary to know all the details to appreciate what happened in London three centuries ago. However, it is worthwhile to look at how ordinary people were drawn into mistakes that left many of them ruined.

Money from nothing

At the start of 1720, stock in the South Sea Company was changing hands at £128 per share. The company was only moderately profitable, and the trade it ran between Britain and South America was small.

Its directors, however, were full of stories about how the riches of that continent were ready to be brought to Europe. Since the South Sea Company did have exclusive rights to provide the Spanish colonies with slaves, and to send one trading ship to the continent per year, these stories did have a kernel of credibility. They were, however, easily inflated.

The South Sea Company's main business had always, in fact, been supporting the British national debt. Since 1711 it had provided millions of pounds in funding to the government by selling its own shares.

It had become so important to the state that King George I was appointed as the company's governor in 1718. In 1719 it agreed to restructure more than half of the national debt in a way that would reduce the government's interest payments.

Growing interest

This gave the company room to issue even more shares on the public market. To make them more attractive, the directors not only pushed the idea that its South American trade was set to take off, but also came up with a scheme that allowed investors to buy these shares in instalments rather than having to pay the full price upfront.

This made them available to many more people, a lot of whom had no real idea what they were buying. They were however seduced by the rising share price and the tales of South American wealth.

By February, shares had climbed to £175, and in March they reached £330. May took the stock to £550.

Not wanting to miss out on this opportunity, more people bought more shares, and the price went up further. In August, the stock was up almost ten times in just eight months, at over £1 000, and the euphoria was at its peak.

However, just as suddenly as it had began, the bottom fell out of the market. At the price being asked, there were simply no more buyers.

Within months, demand for the shares collapsed. By December, the company's shares had slumped back to £124 and many people had lost huge amounts of money.

Repeating history

The lesson most often associated with this series of events is that investors should be wary of anything that becomes a 'sure thing' in popular opinion. Almost everybody was certain that shares in the South Sea Company were only going to keep going up, and the rapidly rising price appeared to confirm their view.

The danger is that when this kind of thinking takes hold, it does become a self-fulfilling prophecy for a while. The price of South Sea Company shares kept going up because people kept buying them. However, at some point the limit of buyers will be reached, and from there the crash back down can be brutal.

The more subtle lesson, however, is that most of the ordinary investors who were buying the company's stock did not know or understand what they were buying. Not only was trade in shares still novel to them, but they did they not appreciate that the South Sea Company's shipping operations were not its main focus. They also had no idea of the complexities involved in its relationship with the British government.

A recent Bloomberg article noted how more and more ordinary investors today are buying complex financial products that have become available to them due to technology. These include forex, leveraged exchange-traded products and cryptocurrencies.

These products are not necessarily going to create bubbles, but they do seem 'sexy' because they can make rapid gains. This, however, is exactly what makes them dangerous. Anything that can go up quickly can can down just as quickly, and these sudden price movements can be devastating.

The South Sea Bubble should stand as a reminder that successful investing is not about chasing the most exciting opportunities. It is actually the opposite: be boring. Diversify, keep your costs down, and let the market do its work over time.

Photo by Annie Spratt on Unsplash

It’s not mentioned often enough in the financial media that many of the keys to success as a long-term investor derive from qualities that are distinctly out of tune with the times. These include patience, discipline and crucially, delayed gratification — a readiness to prioritise distant rewards over instant ones.

In fact, the times we’re living in are almost antithetical to long-term investment. We are overwhelmed by choice. We are told we can have everything we want right now. And, if we can’t afford it, we can put it all on the plastic and worry about paying for it later.

All gain-no pain has a ready market 

The fact is there’s a ready market for the notion of all gain-no pain. Witness the dieting magazines that promise their subscribers perfect bodies with little expense or effort other than the cover price and sticking reminder listicles on the refrigerator door.

It works similarly in the investment world. Much of the financial services industry, and the media that serves it, wants people to believe in the idea that investment returns come down to “hot tips” and easy shortcuts. The giveaway pitch is “high returns with low risk”.

A dissenting view about the instant gratification, you-can-have-it-all-right-now economy has been memorably expressed by Charlie Munger, the business partner of legendary investor Warren Buffett and a man known for turning conventional wisdom on its head.

We can’t stand to wait

“Waiting helps you as an investor and a lot of people just can’t stand to wait,” Munger once said. “If you didn’t get the deferred-gratification gene, you’ve got to work very hard to overcome that.” 

Perhaps it’s due to the nature of modern consumer capitalism, which runs on encouraging people to pursue an endless and unquenchable cycle of externally generated desires. In other words, the notion of delayed gratification is out of tune with the times we live in.

But the ability to forgo today’s desires for the prospect of longer-term fulfilment is one of the most elemental requirements for success as an investor. Buffeted by media noise and the lure of short-term returns, we have to be able to resist the temptation to tinker.

Again, as Munger put it: “People are trying to be smart. All I am trying to do is not to be idiotic, but it’s harder than most people think.” 

One in five don’t plan for the long term at all

Just how hard it is was highlighted in a recent report by the UK online wealth management firm MoneyFarm, which looked at why as a society we seem to find it so difficult to invest in our future wellbeing and are so easily distracted by short-term temptations.

The research found that 21% of Britons don’t plan for their long-term future at all. And a further quarter (25%) think less than six months ahead. Five years was the furthest that most people (29%) currently plan for.

The causes of this short-termism are many, the report says, including a surfeit of choices and a subconscious view that by opting for one we limit our own freedom. Another factor is that thinking about our long-term future creates anxiety, which we treat with instant consumption.

How do we deal with it? The report recommends a number of strategies, such as imagining the most positive outcome from a change in our financial behaviour and consciously thinking about the biggest obstacles to our getting there.

Social support is important

Another underrated technique is galvanising social support around our goals from friends, family and professional advisers. The need, as Munger says, to wait patiently, to not do stupid things and to stay focused on a long-term goal is hard to do alone.

But the first step is setting the goal and building a plan to achieve it.

You can download the full MoneyFarm report here.

Check out more of the latest news from IFAMAX:

Pay less attention to weather forecasts

How women view money and investing differently

A little encouragement goes a long way