A long-time reader recently asked:
Once an investor has a strategy, how can he develop his potential? What should he be reading, or doing? Once you have a screen with certain criteria, then what? Its in our nature to fiddle, to feel like we are doing something, so what should an investor do to develop his potential further?
This is a great question that almost answers itself. It gets to the heart of the problem that many active investors have, and that’s the idea that they always have to be doing something.
It just seems natural that if you want to beat the market then you should be working hard because all the big professional outfits have legions of analysts working long hours to invest money for their clients. If hard work is the route to success for them, and hard work is the route to success in most things in life, then surely even more hard work is the route to success as a private investor?
I think that view is understandable, but wrong.
The lazy way to beat the professionals
As an investor, I can more or less match the market with minimal fees by investing in an index tracking fund or ETF. The effort required for that approach is little more than is required to make and drink a cup of tea. If an investor wanted to hold a portfolio of stocks and bonds and rebalance between them on an annual basis, then the effort might stretch to a cup of tea and a sandwich, once a year.
So at its most basic level, investing is not hard and it does not take great amounts of effort to do it effectively, because as most people know by now an index tracking strategy will beat most professional investment managers after fees.
Act like an owner, not an employee
Index tracking works because it makes use of the fact that you own the businesses in which you invest, rather than work for them. There is a clear distinction between owning a company and working for it. In fact, one of the main reasons for owning a business in my opinion is so that you can hire managers who do the work for you so that you can lie on a beach instead, and perhaps read monthly updates on the company’s progress.
Let’s have a closer look at that index tracking strategy. If you buy the FTSE 100 then you own a collection of 100 very large companies, or at least small pieces of them. Each company probably has many thousands of employees, from frontline workers through various layers of management right up to the board of directors. The whole structure of each business should be geared towards supplying you (the owner) with a good return on your investment. Just think of all those thousands of people, working hours every day just to make you money.
That’s my first point then. The job of the investor is not to work hard, but to find other people to do the hard work instead.
That’s not to say that investing is easy; but the hard work that an investor should do is very different to the hard work done by most people.
Work hard, but not often
There is an extreme example of this in the habits of Warren Buffett. Buffett first bought Coca Cola back in 1988 and he still holds it today. That’s 24 years and a whole lot of returns from a single investment analysis and decision to buy.
And that’s the second point. An investor’s work is done almost entirely before an investment is made, and each investment is almost by definition a reasonably long-term affair. This means that there can be periods of intense work when an investment thesis is being developed, but this is typically interspersed by much longer periods of inactivity when there is nothing to do, and it is this inactivity that gets people into trouble.
Buffett has said this himself many times, whether it be the idea that 20 good decisions in an investment lifetime is probably good going (the 20-slot punch card) or that one good idea in a year is an achievement. Investing is not a daily slog, nor should it be.
Many people struggle with the idea of earning money whilst ‘doing nothing’, but understanding and being at ease with that idea is essential to being a good long-term investor.
There’s a quote from Buffett where he says that he goes to bed thinking about all the facial hair that’s going to grow overnight that will need shaving off the next morning, and how that will lead to many more millions of Gillette razors (a Buffett holding) being sold.
Learn, believe, apply, persist, succeed
Once an investor has a strategy, has honed it and used it and moulded it to fit his or her personality, then the main thing left to do is to apply the strategy. It’s all about the diligent application of a sound strategy, not the continuous tweaking and fiddling of a strategy just to give that processing powerhouse inside our skulls something to do.
Of course we must all keep reading and keep learning, especially from our mistakes, but once an investor is past the beginner stage then the job is no longer about accumulating more knowledge, it’s about more discipline, patience, belief and occasionally, doing nothing.
Further reading
Hi John, I took quite a lot of modules on control theory at uni and have an unhealthy interest in feedback loops as a result! One of the things I struggle with in my blundering attempts at value investing is that there can be a long wait before you get any feedback (i.e the market sentiment toward the investment changes to reflect its “true” value). how do you tweak your strategy based on your past experiences, given the potential time frame?
In addition to this, I think Buffett once said that investors should be comfortable with a holding dropping in value by up to 50% before the value is recognised. It takes a lot of conviction to follow a long-term strategy, with potentially large swings in capital value as a young/inexperienced investor – how do you handle it?
I appreciate those are expansive questions but your write-up got me thinking!
Best regards,
Guy
Excellent questions Guy.
On the first one, I think the amount of lag in the feedback is quite possibly the biggest hurdle there is. Not only that but the feedback is often of terrible quality! For example, I bought Robert Wiseman Dairies and then was bought out by Muller Dairies 9 months later at a 30% profit. Does that mean I did the right thing, or was I just lucky? It’s very hard to say!
I have been a value investor for about 5 years and the first 4 of those were my ‘beginner’ period. I have had 3 major phases of strategy development. The first one lasted about 3 years, the second one about a year and I’ve been using the final approach for about a year, although I don’t expect to tweak this final version to any great extent in the future. So in my experience it’s at the very least a year before you can see if you’re doing something stupid. If you’re not doing something obviously stupid then I guess it can takes years before you find out if what you’re doing is good or not.
Most people just cannot accept a feedback loop that takes years rather than seconds or days at most.
So I would say that the speed of methodological tweaks is proportional to how obviously bad the thing you’re trying to tweak is.
On your second point, I think the way to handle any share price volatility is to be sufficiently diversified (I hold 30 companies); to hold companies that are unlikely to have a volatile intrinsic value and share price (I hold things like Vodafone and BP, although their share prices can still be volatile); and most importantly, to have a robust idea of what that stable intrinsic value is.
That’s why I value companies on 10 year data like PE10 and 10 year growth rates, because in any given year the intrinsic value isn’t likely to change by more than 10% or so. That way I can see the 20-50% share price swings for what they are – changes in investor sentiment rather than changes in the intrinsic value of the companies I hold.
So if Vodafone drops by 50% it will probably be quite obvious whether or not the intrinsic value has dropped by that much. If the value hasn’t changed but the price has, then I’m not bothered by massive falls.
Recently one of my holdings, Braemar Shipping, dropped by several 10s of percent, but it’s come back recently. Now another holding, Chemring, has dropped. Has the intrinsic value changed? Not that I can see. So in my opinion this is just the fickle nature of Mr Market and doesn’t truly represent changes to the companies that I own.
I hope that’s something for you to chew on…
“So I would say that the speed of methodological tweaks is proportional to how obviously bad the thing you’re trying to tweak is” – I meant time is inversely proportional to obviousness…
I agree with this article, a lot of people are doing hard work because their boss requires it. An investment might be simple and easy to understand but a professional needs to put 80 hours of work into it to make sure there’s no “career risk” involved.
What I’ve learned as I’ve been investing is that it’s important to turn over a lot of rocks. And of those rocks I turn over not many are actually good investments.
When I first started out I thought everything looked great, of course this was because I had no idea what I was looking for. The longer I’ve been at this the more I can catch and rule out.
So I’d say I spend 90% of my time looking at companies that I never buy and that last 10% looking at companies I do end up buying. I can safely ignore (mostly) my portfolio because I’m concentrated on finding new companies by turning over rocks. Here and there I’ll checkup on my current holdings but I don’t obsess over them.
Hopefully this helps!
Nate
Exactly. Once you’ve got most of your methodology sorted out then just get on with applying it to stocks. Over time there will be a tweak here and there but most of the work is analysis rather than adding new bits to your methods.
In fact most of what any investor needs to know was written down way back in the 1930s and 40s, and only a tiny amount of really new thinking has occurred between then and now.