Believe it or not, it is behaviour that is the clincher in investment success or failure. Benjamin Graham believed that the investor’s chief problem is likely to be himself. What he meant was that people let their emotions get in the way of smart investment moves.
Here are three lessons to keep in mind.
Caution yourself against the herd mentality.
Howard Marks says it well: When things are going well and prices are high, investors rush to buy, forgetting all prudence. Then, when there’s chaos all around and assets are on the bargain counter, they lose all willingness to bear risk and rush to sell. And it will ever be so.
In order to be a successful contrarian, you have to do the opposite of what the herd does. In his book The Most Important Thing, Marks says that “most people are driven by greed, fear, envy, and other emotions that render objectivity impossible and open the door for significant mistakes.”
How does one keep emotions at bay? If you are a stock market investor, you must possess a strong sense for intrinsic value where your investments are concerned because most people ignore this at the extremes.
If you are a fund investor, you need to resist the psychological pressures that make most people err, and thus buy when most people are selling and sell when most people are buying. Or at least don’t rush to sell your investments when the market tumbles. Understanding the fund’s investment mandate will help.
In both cases, accept the fact that volatility comes with the territory.
Accepting the broad concept of contrarianism is one thing; putting it into practice is another. Going against the herd may sound savvy but requires tremendous courage. It’s not easy going against the grain and taking views that are contrary to the consensus. And it can be extremely painful when the trend is going against you.
You have to be willing to look wrong for a while. If the herd is doing the wrong thing, and if you are capable of seeing that and doing the opposite, it is still highly unlikely that the wisdom of what you do will become apparent immediately. Usually the crowd’s irrational euphoria will continue to take prices higher for a while – possibly a long while - or its excessive negativism will continue to take prices lower. The contrarian will appear wrong and look like an oddball loser.
Always have a rationale for your investments.
Anthony Bolton’s advice to investors was that they must know why they own a stock. Every stock must have an investment thesis. The thesis must be retested at regular intervals and a counter thesis should also be in place - what might lead it to become a bad stock.
Bolton believed that there would be some reasons certain investors don’t like a particular stock regardless of how positive the outlook for a company. And he, as an investor, should know why he disagrees with each of the negative factors.
Ditto when investing in a particular fund. Be aware of the fund’s investment mandate. Does the fund invest in large caps or smaller fare or is a flexi-cap offering? Does the fund manager tilt towards a high cash balance? Are you ok with it or would you prefer he be fully invested at all times? Does he adopt a buy-and-hold strategy or does he churn a lot? Does he take a top-down view or combine it with a bottom-up strategy?
If you have your basics sorted out, chances of you faltering and running for the exits in a falling market are slim. And half the battle would then be won because it is in bear markets that people make money. Michael Price says it well: The key is weathering the bear markets, not outperforming the bull ones.
As far as investing goes, time is your friend and patience is a virtue.
If there is any renowned investor who has drummed this point home it is Warren Buffett. Though conveyed using different words, he has been emphatic about it over the years.
The stock market is designed to transfer money from the active to the patient.
If you aren’t thinking about owning a stock for 10 years, don’t even think about owning it for 10 minutes.
Time is the friend of the wonderful business, the enemy of the mediocre.
When buying into a company which has a bright future, it will be foolish to exit soon. Quality businesses earn high returns and increase in value over time. Fundamentals can take years to impact a stock’s price and the patient will be rewarded.
Take the example of a fund that has been around for a very long time – Franklin India Bluechip. Over a 3-year period (2012, 2013, 2014), the fund’s annual returns consistently underperformed the category average. But the fund bounced back after that and its long-term performance numbers (3-, 5-, 10-, 15-years) are all above the category average. Investors who exited the fund due over that period would have erred because intrinsically the fund is a solid offering. It has an excellent record. It follows a disciplined stock picking process. And it is a product from a very well reputed fund house.
Any equity investment would go through the occasionally rough patch. As Barton Biggs says “all good investors have cold spells”. And that includes fund managers. Don’t panic at the slightest sign of turmoil.
