Patience is bitter, but its fruit is sweet. - Rousseau
I recently attended the CFA Society of Chicago's annual dinner where a fellow attendee and I discussed how one of the more humbling things about going through the CFA Program, besides the difficulty of the curriculum and exams, is that you get a very real sense of the level of competition you face as an investor.
Depending on the location of your CFA test center, you could be taking the exam with over 1,000 other capable, well-educated, and motivated investment professionals, some of whom have flown in from overseas at their own expense because their country doesn't have a test center. Yep, that motivated.
You then realize the people you see are only a fraction of the global investment professionals with whom you're competing in the market every day.
We know that in order to produce different results from other investors you must have a different approach, but how to differentiate yourself amid such formidable competition isn't obvious.
This passage from the 1996 Berkshire Hathaway letter provides two solid options (my emphasis added):
Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.
Should you choose, however, to construct your own portfolio, there are a few thoughts worth remembering. Intelligent investing is not complex, though that is far from saying that it is easy. What an investor needs is the ability to correctly evaluate selected businesses. Note that word "selected": You don't have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.
To invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets. You may, in fact, be better off knowing nothing of these. That, of course, is not the prevailing view at most business schools, whose finance curriculum tends to be dominated by such subjects. In our view, though, investment students need only two well-taught courses - How to Value a Business, and How to Think About Market Prices.
Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now. Over time, you will find only a few companies that meet these standards - so when you see one that qualifies, you should buy a meaningful amount of stock. You must also resist the temptation to stray from your guidelines: If you aren't willing to own a stock for ten years, don't even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio's market value.
In other words, you can concede that you don't have an advantage over the market and build a diversified portfolio using low-cost index funds (which is a fine option), or you can aim to outperform by investing in businesses you understand, paying a good price for them, and holding them for the long-term. (Also see: A Simple Formula For Investing Success)
You could also do a little of both, of course, which is often called the "core and explore" or "core and satellite" approach.
You could also do a little of both, of course, which is often called the "core and explore" or "core and satellite" approach.
The common thread, whichever strategy you choose, is patience and emotional self-control. As we've said here before, individual investors can't sustainably out-trade the institutions and that patience is the individual investor's greatest advantage over the market. We need to stick to our strengths.
Our efforts as individual investors would be put to better use if we focused on learning to analyze businesses and control our emotions -- buying when others are selling, doing nothing when others are trying to force returns, etc. -- rather than trying to outfox other investors in the short-term.
Though this is hard to do, I think it's the best way we can differentiate ourselves in the incredibly competitive marketplace of investors. To borrow a phrase from A League of Their Own, "It's supposed to be hard. If it wasn't hard, everyone would do it. The hard...is what makes it great."
What I've been reading & watching this week
- Sensible Investing recently completed a very well done 10-part video series on the investing industry.
- Managing someone else's emotions - A Wealth of Common Sense
- The latest edition of the Graham and Doddsville newsletter - via Market Folly
- Probability and competitive advantage - Richard Beddard
- Seth Klarman on EBITDA - Hurricane Capital
- The problem with low volatility - Monevator
- Why dividend cutters may make for good investments (after the cut) -- The Value Perspective
- Your personal margin of safety - Abnormal Returns
Stay patient, stay focused.
Best,
Todd
@toddwenning on Twitter
