Housekeeping
Like always, it goes without saying that what I write in these posts is not financial advice. Also the opinions here are solely my own and they don’t represent the views or opinions of any company I might be affiliated with at the time of writing.
I’m not even trying with this disclaimer anymore.
Ramblings
Three things I want to ramble about today that shape the way in which I view investing at its core:
Investment Philosophy.
Short-term Thinking
Emotional Resilience.
Investment Philosophy
One of the most dangerous misunderstandings in investing is the idea that there is only one way to succeed. The way I see it, investing is such an appealing endeavor precisely because it allows for incredible amounts of flexibility in your approach. Some people succeed by buying great businesses at a fair price and acting sporadically, while others succeed by developing algorithms that trade in-n-out of positions in a few seconds. Some succeed by buying stocks, others earn their riches in real estate, while some flip shitcoins on 100x leverage with their family’s life savings.
There are a multitude of investment strategies that can work in the market (flipping shitcoins with 100x leverage probably will not. Sorry to ruin your day). A lot of the disagreements I see between investors arise from the inability to recognize the merits of a different approach. This is good, because in a way it is what “makes a market”. The long-term fundamental investor and the short-term speculator need each other. Clearly one thinks that the other’s approach is suboptimal in some way.
Some of the key common traits I’ve identified in the vast pool of successful investors I have read about are:
Emotional resilience;
Intellectual honesty & rigor;
Consistency.
I put emotional resilience at the top for a reason, so I will touch upon it in the last section, but don’t sleep on consistency. Sticking to your approach is absolutely essential to succeed. Flip-floping between the most popular flavour of the time will surely lead to mediocre results.
Consistency requires conviction, which is where your investment philosophy comes in. Your investment philosophy refers to your view on markets and on which investment strategy you think will lead to the most benefit given that view. By “view” here I don’t mean your short-term forecast on what market prices will do, but rather what you think are the fundamental drivers of returns for different asset classes, and whether you think any asset class has inherent advantages over others.
How do you think about asset allocation? Do you think it’s better to have a portfolio diversified across asset classes? Or do you think you’ll do better by sticking to one asset class, such as stocks or real estate?
What do you think about diversification? Do you feel more comfortable owning funds which are diversified across many securities, or do you prefer to own a smaller number of individual securities that you know very well?
Are you an investor or a speculator? Do you focus in the long-term or do you want to trade in-n-out of positions regularly? Are you buying assets because of their future cash flows, or do you only care about whether you can sell it a higher price in a few weeks/months/years? Do you think short-term trading can actually deliver sustainable long-term returns?
What is your edge? Do you possess any type of unique knowledge, skill, or experience that gives you an advantage in some corner of the market?
Answering these questions will help you to arrive at your investment philosophy, which should then be your anchor. Every action you make should be aligned with your philosophy and you must not deviate from it, unless you decide to adapt it as you learn. The trick is then to distinguish when updating your philosophy makes sense and when you might need to recognize that your chosen approach is not working.
The Short-term Thinking Epidemic
“One thing every investor needs to think about is identifying their edge… We think the biggest edge any investor can have, and the biggest edge we do have, is a long-term orientation. It’s easy for people to say they have a long-term orientation, but it’s harder to actually have one.” - Seth Klarman
The average holding period in a stock is now less than 6 months! From the rise of high-frequency trading to the spread of short-term trading strategies based on technical analysis promoted by “gurus”, it seems that focusing on the long-term is now a niche strategy. In Wall Street, “long-term” is now defined as anything beyond 3 years. This is…ehhhh…curious. I mean laughable.
One fact that I always keep in the back of my mind is that the business models in the financial services industry often revolve around transaction fees, commissions, and/or management fees. It’s in their best interest for you to trade as often as possible, because they get a cut from every transaction. Importantly, it’s also often irrelevant for them whether you actually get the best performance possible in the long-term, as long as you keep paying fees to park your money with them.
Moreover, professional managers (those who manage money for others) are often under big pressure to show positive results quickly because their investors are inpatient and want results right away, even if that might compromise the soundness and sustainability of the strategy.
That’s an enormous advantage you and I have over professional managers. We’re not bound by quarterly performance numbers, and we’re not harassed by nosy investors who ramp up the pressure. We have the freedom to analyze investments with a long-term orientation and to wait for our thesis to be proven correct without anyone breathing down our backs. Of course, intellectual honesty & rigor are needed to hold ourselves accountable on the quality of our analysis and the consistency of our actions. I have been thinking often about the saying that”what is right at one price is wrong at another.” Whether you have the patience and analytical capability to buy at the “right” price is something only you can control.
In my opinion, the bias for short-term thinking that is prevalent today creates fantastic opportunities for those sharp and patient enough to think in decades. Far too often, investors today pay too much attention to quarterly profit numbers or patterns in a graph while ignoring the big picture. I have to say, there is nothing wrong with short-term speculation, as long as no undue risk is taken and adequate probabilities are calculated, but you have to know which game you are playing.
The age of social media has enticed us to crave small-but-frequent dopamine hits, but just as it’s true in other aspects of life, delaying gratification and focusing on the long-term is probably the most sound approach for sustainable results in investing. Nobody wants to get rich slow. This means that the slow path is less congested.
Emotional Resilience
“Everyone has the brainpower to make it in stocks. Not everyone has the stomach.” - Peter Lynch
I said above that emotional resilience was at the top of the list for a reason. The reason is that I think that emotions are the single biggest obstacle for successful investing.
The issue is so acute that even people who are extremely smart, honest with themselves, and ruthlessly consistent, make mistakes when shit hits the fan. It’s just human nature. We have a survival instinct that we developed in the wild that helps us avoid dangerous situations. Unfortunately, in markets it usually just leads to panic-driven decisions.
If you don’t believe me (or if you think you’re too smart for this to apply to you), please humble yourself by reading the experience of one of the smartest men that ever lived.
Fact of the matter is, the vast majority of people are not cut out to be active investors. Most people panic when they’re supposed to be opportunistic, and they get greedy when it’s time to take some money off the table. Just listen to Terry Smith’s explanation in the video above.
You are your worst enemy.
If you’re able to master your emotions, then good for you. Now you have to figure out whether you have the intellectual honesty & rigor, as well as the consistency to become a successful investor.
But if you don’t, don’t worry. As I’ve written extensively before, that is why index funds exist and why some of the world’s most renowned investors (Warren Buffett, Jack Bogle, etc.) recommend them for regular folks.
If you still decide to be an active investor, there is a good tip that has been very useful for me. Write down the rationale for every decision you make. Every time you buy or sell something. Even every time you decide not to buy or not to sell something. Write it down. Later, a few months down the line, look at what you wrote and evaluate the quality of the decision and of the analysis. Keeping a log like this is a great step in becoming a better investor by learning from mistakes and building up from high-quality decisions. You can thank me later.
Thank you very much for reading! Hope you enjoyed and that it was at least a tiny bit useful! Until next time!