Wall Street has a tendency to overemphasize short-term benefits at the expense of long-term benefits . . . There is a reward given to pursue short-term actions that provide a short-term benefit at the expense of long-term value to your company.

- Doug Geoga, Hyatt Hotels

I am a long term investor, but I find myself living in a short-term world. The stock market feels more like my manic ex-girlfriend: Always moody, always demanding performance, and totally unpredictable (Oh, and she took my money away too).

A few years ago, I came across a timeless article published by Legg Mason Capital Management. Frankly, I don't know anything about them other than the fact that they write damn good thought leadership articles. I would like to share it with you.

The article, "How Psychology and Incentives Shape the Investment Industry", was published in May 2006 by Michael J. Mauboussin and does a great job of explaining exactly why the market is so similar to my ex-girlfriend in the short term.

Mauboussin introduces the concept of Short Termism, which he defines as 'a heavy focus on short-term results'. It is not hard to think of examples of Short Termism when looking at the Markets (e.g. Investors dumping or buying up shares on earnings announcements, Day Traders, etc). Mauboussin continues to describe the causes of Short Termism as a consequence of Incentives (i.e. CEO Pay is More Tied to the Stock Price than Ever Before), Psychology (i.e. Human stress and fear response), Information (i.e. Media and Wallstreet are paid to generate information), and Rate of Change (i.e. The apparent acceleration of the rate of change for businesses creates a final source of shorter time horizons).

Short Term Sucks

Why do we care? Short term thinking sucks for a number of reasons:

There is Hope

But hold the phone kids. Mike Mauboussin is a glass half full kind of guy, and indicates that "Individuals who can, under the proper conditions, think and act with a long-term perspective stand to benefit from the short-term focus of others." However, he warns to not mix strategies by attempting to deliver superior long-term returns with strategies and behaviors rooted in short termism.

His big method for this is Time Arbitrage.

Scary name right? I know. But seriously, it is pretty simple stuff. Mauboussin uses the example of a coin toss to explain this. Check it: Mauboussin describes a coin toss where after 20 tosses, heads came up 35% of the time. That is the short term results. If you keep tossing the coin over and over, eventually you will get closer and closer to 50% chance of heads (or tails for that matter). Mauboussin's point is that the shorter the time horizon, the more 'noise' (volatility) you get which can deviate from the real long-term signal (Which is 50% in the case of the coin toss).

Time Arbitrage simply means that most investors (i.e. Bankers, individuals, and fund managers) tend to suffer from short termism, and therefore have high turnover or are trying to exploit very short-term anomalies in the stock market.

To summarize, Mauboussin is just stating that Time Arbitrage enables Value Investing (i.e. Buying good stocks at cheap prices).