Busy-ness is a disease.
“Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.” – Warren Buffett
There are 2 potent lessons in this quip from Uncle Warren:
- Don’t invest based on “what other people are saying” or “what other people will like”. Invest based on your data and reasoning, or that of someone you trust.
- “I have always found it easier to evaluate the weights dictated by fundamentals than votes dictated by psychology.” - Buffett
- Don’t trade much.
- “...ignore the chatter, keep your costs minimal, and invest in stocks as you would in a farm.” – Buffett
Busy-ness doesn’t help in the game of investing. It’s as if returns of a portfolio are inversely proportional to the number of trades. I can tell from experience that this is true, more or less. Busy-ness points to 4 problems:
- It’s symptomatic of FOMO and YOLO – the tendency to buy into stocks or assets that everyone else says “is the next Google or Amazon”.
- It’s symptomatic of our tendency to react to every bit of sensationalist or click-bait news.
- It’s symptomatic of our tendency to sell out of perfectly good investments too soon, often because we’re attracted to shiny new things that everyone else is screaming about.
- It increases transaction costs.
In short, busy-ness usually hurts returns. The next logical question is, “so, what should we do? Nothing?” No, not nothing. But close.
Keep it simple.
At The Buylyst, we like to keep things as simple as possible. In looking for investments, we look for 3 main characteristics:
- A Comfortable Business
- A Comfortable Price
- …playing the right sports
Obviously, we spend a lot of time and effort in identifying potential investments that meet all 3 requirements. But the fact is that they are rare. Very few meet ALL 3 requirements. And that means that even if we find one potential investment per month, we should consider ourselves lucky. Most of the time, we’re observing, reading, thinking, analyzing and, as Charlie Munger puts it, sitting on our a**.
“If you invested Berkshire Hathaway-style, it would be hard to get paid as an investment manager as well as they're currently paid - because you'd be holding a block of Wal-Mart and a block of Coca-Cola and a block of something else. You'd be sitting on your ass. And the client would be getting rich. And, after a while, the client would think, "why am I paying this guy half-a-percent a year on my wonderful passive holdings?" So what makes sense for the investor is different from what makes sense for the manager. And, as usual in human affairs, what determines the behavior are incentives for the decision maker.” – Charlie Munger
When to buy.
OK. Let’s assume we found that rare investment opportunity that meets the criteria of a comfortable company. To check if the available price is comfortable, we must have an approximate idea of how much this comfortable company is worth. Without that numerical marker, we’re shooting in the dark.
We buy when there is enough Margin of Safety – usually 25% or more. What does that mean? If our comfortable company is available at a price that’s 25% cheaper than our estimation of how much the company (or its stock) is worth, it’s a “buy”.
The tacit assumption here is that we have enough cash on hand to buy. But for most of us, this is a problem. We don’t always have enough cash on hand to load up on our latest diamonds in the rough.
When to sell.
Seriously, that’s Buffett’s advice: Don’t buy if you don’t want to hold forever. As you saw earlier, Munger says that if we all invested Berkshire-style, we’d buy a few comfortable companies (at comfortable prices) and then we’d be sitting on our asses.
But the problem is that we’re not Berkshire. We don’t have a constant trickle of “Float” (insurance premia that Berkshire Hathaway collects constantly, which it then invests). Some people are disciplined in diverting a sizeable fraction of their paycheck to their investment accounts. That’s kind of like a constant trickle of Float. If you’re one of them, I salute you. If not, here’s what to do:
- If one of your holdings is significantly (10% or more) above its Valuation, then sell as much of it as you need (maybe all) to fund your latest find.
- If none of your holdings are anywhere near their valuation, you have 2 choices:
- Do nothing. Hold on to what you have and pray that your new find remains cheap until you have more cash to invest.
- Sell the one investment in which you’ve lost confidence over the past year or two. Maybe management isn’t executing. Maybe the world has moved on from their core product.
In short, don’t sell unless:
- You have a replacement.
- The facts change – either a company’s competitive advantage shrinks, or your thesis was flat out wrong.
Stay invested in Global Dominators.
There are a few – very few – Global Dominators that have almost no credible competition. I spent some time on these last January (it’s time for a revisit). A few usual suspects are Apple, Google, Microsoft, Amazon, TSMC, Disney. If you have them in your portfolio, keep holding them unless the facts change. Unless someone comes up with a better search engine (unlikely), Google’s a good hold if you’ve got in at a good price.
I try to keep 10-20% of my portfolio always invested in these Global Dominators – if they’re already in my portfolio. The caveat is important. I wouldn’t buy anything new unless there is margin of safety. But I would hold on to something if it has already reached my estimate of how much the stock is worth. It’s a matter of Risk. There is less risk in a known company that has demonstrated excellent performance, especially if that performance is attributable to reasons you identified in your thesis. Let the music keep playing. The key, of course, is to keep tabs on these dominators to check if they’re still, well, dominant.
Disruption comes out of nowhere. Stay invested in these dominators. But have a distinct worldview.
Risk Management is not Volatility Management.
Academic and Wall Street Professionals make the same mistake – they think Risk equals Volatility (or Standard Deviation). I’ve spent a lot of time trying to wage a war against this notion. If you’re trading and your time-horizon is short (meaning you’ve got to show returns in a month or two), then volatility matters. But if you’re an investor, which implies that you have time on your hands, volatility is just an emotional inconvenience. Nobody likes a 10% crash. But the crashes are not dangerous, unless you act on it. Reminder: Don’t sell when markets crash. If you have dry powder (some cash on hand) and a Watch List, lollapalooza!
Risk comes from not knowing what you’re doing. That’s what Buffett believes. And that means don’t spread your bets too thin. Focus. I think of focus in terms of number of investment themes and number of investments. I have rough markers for each: About 10 themes and 20 investments. Keep it simple.
Buffett’s suggestion is that if you know – deeply – where you’re invested and why, you’re already managing Risk. The other risk he warns us against is the risk of overpaying. This goes back to Margin of Safety. Buy stuff at a discount!
“The greatest risk doesn’t come from low quality or high volatility. It comes from paying prices that are too high. This isn’t a theoretical risk; it’s very real.” – Howard Marks
Don’t time the market.
Last but not least – don’t worry about bull markets and bear markets! I’ve spent almost two decades in this profession and I can tell you with utmost confidence that nobody can predict how much and how fast the overall equity or debt or commodity markets will move in the next 1, 2, 3 or 6 months. Financial news channels constantly bring on guests to pontificate. This is just click-bait (what’s the equivalent of click-bait for TV?). If they’re so good at predicting overall markets, they wouldn’t be working at XYZ Brokerage firm. They’d be running their own shop.
I’ll leave you with 2 lessons about this:
- Don’t pay attention to Market “strategists”.
- “Market Forecasters will fill your ear, never your wallet.” - WB
- Focus on what you can reasonably estimate: A company’s competitive advantage, it’s durability, the quality of its management, and its rough valuation given your assessment about the first 3 points.
- "I’m firmly convinced that (a) it’s hard to know what the macro future holds and (b) few people possess superior knowledge of these matters that can regularly be turned into an investing advantage. There are two caveats, however: 1) The more we concentrate on smaller-picture things, the more it’s possible to gain a knowledge advantage. 2) With hard work and skill, we can consistently know more than the next person about individual companies and securities, but that’s much less likely with regard to markets and economies. Thus, I suggest people try to “know the knowable.” - Howard Marks
- Know where you’re invested and why – keep it focused and simple.
- Focus on a company’s competitive advantage, the durability of that advantage and your general feeling about the management team.
- If you have time, do a quick estimate of how much you think the company’s worth. This should be a range, not a precise number. Don’t obsess over this, #2 is more important.
- If the stock is trading at a severe discount to your range, it’s worth buying. Otherwise, move on.
- Don’t trade often. Don’t buy often. And sell only if you have a replacement.
- Don’t time the market.
Many Happy Returns!