Pop quiz: What’s the opposite of success?
Did you guess failure? Good guess but that’s not correct. The opposite of success if apathy – just not giving a damn.
Which is very odd if you pause and think about it.
So many want the sweet fruit of success. I’ve never met anyone who didn’t. Yet, the obstacle to the very success that everyone wants is….themselves. They simultaneously want something very badly and yet, couldn’t care less about doing what it takes to achieve it. How ironic.
I see this played out with stock investors every day. While the reasons for achieving success vary and are personal, the goal for every single stock investor is the same – to make money.
But you wouldn’t know it.
The track record for individual investors is terrible. From every study ever done about the market, we know the S&P 500 Index averages about 10% a year. And what of the individual investor? They average half of that, around 5% or less.
Why do they do perform so badly? Apathy.
Now, some of you may be thinking that the individual investor’s Achilles heel is his/her emotions. And you’d be right. The individual investor does make poor decisions out of emotion – buying high and selling low. Overreacting. Following the herd.
But what’s behind all of those bad behaviors is apathy. A complete disregard for knowing what really works in the market. The average investor can’t be bothered with knowing. Which is why stock investing is such a paradox for many –it’s both very important and not important enough…to understand.
But that’s not the case for you my dear reader. The whole point of reading a blog like this one is that you want to educate yourself. You’re willing to delve into the unknown. It’s not OK for you to be in the dark. You want to understand the principles of success because you know if you do, you’ll master them.
So, what does work in the market?
A few simple principles that are, as you might expect, the opposite of what everyone else does:
- Buying low. As simple as this concept is, so many screw it up. Most investors look at the stock market as a beauty contest. They buy what’s pretty. Which is to say, they buy what’s been going up and up. Have you ever noticed the language of sports fans? When their team wins, it’s “Hey! WE won!”. And when their team loses? “Wow, I can’t believe THEY lost”. Nobody wants to associate with a loser. Everybody wants to be with a winner. But this “opposite” behavior is what causes investors to buy high, the very recipe for below average returns. The best way to buy stocks is like you buy groceries, not like you buy perfume. Look for bargains. Buy good businesses selling at a discount. And yes, this means you’ll probably be buying when everyone else is selling – during market meltdowns, when everything looks ugly. When everything stinks. The point here should be obvious. You obviously want a positive gap between what you pay for a stock and what you sell it for. Friends, the reason the individual investors earn such meager returns is because they are buying stocks at or near the top of the market. They then sell them shortly afterwards when the market turns south, thus creating a gap in the opposite direction – selling below what they paid for the stock – a recipe for mediocre returns. Friends, you pay a dear price for a cheery consensus in the market. Be patient and be smart. Buy low.
- Buying shares in a company and industry you understand. Warren Buffett famously has a paper bin on his desk labeled “To hard”. When Buffett comes across a company whose financials, products and/or industry are too difficult for him to understant, he simply puts them in the “too hard” category and forgets about them. Buffett learnt this investing strategy long ago; he loves “boring” businesses like utilities, soft drinks, toothpaste, bricks and carpet manufacturers. The average investor wants a whiz bang, “shoot-the-lights-out” stock that they can ride to the moon. The problem with that? Most of those moon rides come crashing down to earth about twice as fast as they went into orbit. Rocket stocks tend to gyrate much more to the day’s events than boring companies do, and they’re also very unpredictable. Having some idea of what,and where, a company will be 10 years from now is extremely important to the investor’s psyche. Extreme volatility will make even the most hardened investor want to buy or sell at precisely the wrong time (see #1 above). My friends, investing isn’t speculating, it shouldn’t be a thrill-seeking gamble. Choose high quality companies you understand and whose products you can easily see demand for in the future. I don’t know what hot technology people will gravitate to next year or the next. But I do know that boring products like janitorial supplies and diapers will always be in demand. The “shoot the lights-out” companies may or may not be here tomorrow, but I can tell you that the “keep-the-lights-on” stocks will be. Which brings me to the next point.
- Invest for the long-term. Too many people see investing as a way to get rich quick, but they actually have it the wrong way around. Investing is about getting rich slowly, but surely, year after year. The best things in life take time, and if you try to build a portfolio too rapidly you are likely to fail. This has been proven countless times. In fact, Buffett just gave a master’s course to everyone by winning a 10-year bet against a fund of hedge funds, using a buy and hold strategy towards investing. Every single study has shown that a long-term value investing approach doesn’t just beat all other styles of investing, it wipes the floor with it. The reasons for this should be obvious – fewer taxes, fewer fees and fewer “dances”. The average investor has convinced himself that he’s the “one”. He’s convinced that he has the “Cinderella” gift and can magically dance in and out of stocks at just the right moment, to perfectly time the market. But reality offers a grim report – the average investor proclivity towards the short-term puts him out of the market exactly when he should be in it and vice-versa. There are no called strikes in investing. You don’t get paid for activity. This is precisely why most hedge funds fail to beat the indexes. They’re so active! Eighty to ninety percent portfolio turnover in a single year is not uncommon in hedge funds. And what does all that activity create? Fees. Taxes. Mistakes. All those things put a damper on returns. The market punishes the impatient and rewards the patient. As renowned value investor Seth Klarman said, “The hard part is discipline, patience and judgment. Investors need discipline to avoid the many unattractive pitches that are thrown, patience to wait for the right pitch, and judgment to know when it is time to swing.” Indeed.
Individual investors have a problem. I think it’s because investors are not learning, despite all the education currently available to them. Lack of financial education has reached an epidemic proportion.
In a 2012 study by the Financial Industry Regulatory Authority (FINRA), the brokerage industry’s self-regulatory body, the average US adult correctly answered only 2.9 out of 5 basic financial questions about topics like risk, inflation, interest rates and mortgages. Only 14% answered all 5 questions correctly.
Friends, I see too many people put $5,000, $50,000 and $500,000 into the market with only $5.00 worth of investing education. They hear a hot stock tip on TV or ask a coworker what he or she is investing in. My question to them is this – If you don’t know anything, then how could they possibly know more than you? Although it is possible their coworker is a savvy investor, the odds are against it. It is more likely that the co-worker they asked, found his or her allocation from another co-worker!
My advice to those wanting to be a better individual investor?
Be the smartest person you know about investing. Read every book you can. And don’t just read books about investing, read books on human psychology. Read books on philosophy and human error. Read about economics. Read about accounting. Read, read, read. Be a reading and learning machine.
Don’t be guilty of apathy in something so important as investment. Learn what works. Become wise about it. Use that wisdom to prevail in the stock market so that you can become wealthy. For wealth will enable you to do something else – become financially free.
Be free. Nothing else is worth it.
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