The individual investor
Neither for the faint of heart nor impatient
There are no instant experts in investing. No matter how smart you are, how courageous, how patient, how resilient, how creative, how strategic, how adaptable or how self controlled.
There are two sides to developing expertise in investing. The first is the question of whether you have the right stuff. The second is how you get there, how you develop expertise.
The right stuff
The following from Ben Graham deals essentially with the question of the right stuff. He gave a speech to securities analysts. It was styled “Renaissance of Value”, and was reprinted in Barron’s September 23, 1974, and is quoted by Roger Lowenstein. Graham remarked that investing did not require genius: “What it needs is, first, reasonably good intelligence; second, sound principles of operation; third, and most important, firmness of character.” (Lowenstein, Buffett, The Making of an American Capitalist. 1995,2008) p.160.
Intelligence and character are quintessentially about the right stuff. Sound principles of operation, i.e. a sound investment process, is something you can learn from books and talking to experts.
Getting to superior performance is another thing entirely. It’s not easy to become a really good investor. Consider the following from a paper titled ‘The Making of an Expert’ in the Harvard Business Review, July–August 2007 Issue, by K. Anders Ericsson, Michael J. Prietula, and Edward T. Cokely:
“The journey to truly superior performance is neither for the faint of heart nor for the impatient. The development of genuine expertise requires struggle, sacrifice, and honest, often painful self-assessment. There are no shortcuts.”
The greatest danger
The greatest danger is to think that investing can’t really be that difficult. I mean, after all, Warren Buffett wrote in 1996: “In each case you simply want to acquire, at a sensible price, a business with excellent economics and able, honest management. Thereafter, you need only monitor whether these qualities are being preserved.” (Buffett W. E., 1998) p.89. So, what could be easier!
I have seen a number of investors who thought they were smart, had the right risk-taking qualities, and simply made a hash of it. Overconfidence plays a big part.
I am convinced that anyone with a modicum of brains and good character can learn to be a very successful investor. You just have to realize it takes time and commitment.
The bitterest way
As Confucius said: “By three methods we may learn wisdom: First, by reflection, which is noblest; second, by imitation, which is easiest; and third by experience, which is the bitterest”.
It is worthwhile reflecting on the ‘bitterest’ way to learn. It applies in spades in investing. Make no mistake, in investing we do make mistakes.
In 1923 Edwin Lefevre, a newspaper reporter, published a book called Reminiscences of a Stock Operator. In the book the operator was named Larry Livingston. In real life he was Jesse Lauriston Livermore, one of the most extraordinary stock market and commodities speculators of all time. The book is a delight to read and one of the most popular investment books of all time.
It was republished by John Wiley & Sons Inc. in 1993. It contains many gems of investment wisdom that are equally applicable to investing as they are to trading. The quotes are so colorfully expressed that they make their points memorably. Lefevre was a gifted reporter and while I refer to what Lefevre wrote, the words captured so naturally are really those of Jesse Livermore. (Lefevre, Reminiscences of a Stock Operator 1923,1993)
Lefevre wrote, in the words of Livermore: “The recognition of our mistakes should not benefit us any more than the study of our successes. But there is a natural tendency in all men to avoid punishment. When you associate certain mistakes with a licking, you do not hanker for a second dose, and, of course, all stock-market mistakes wound you in two tender spots – your pocketbook and your vanity.”
“Of course, if a man is both wise and lucky, he will not make the same mistake twice. But he will make any one of the ten thousand brothers or cousins of the original. The Mistake family is so large that there is always one of them around when you want to see what you can do in the fool-play line.” (Lefevre, 1923,1993) p.119.
“All my life I have made mistakes, but in losing money I have gained experience and accumulated a lot of valuable don’ts.” (Lefevre, 1923,1993) p.36.
“After my May ninth mishap I plugged along, using a modified but still defective method. If I hadn’t made money some of the time, I might have acquired market wisdom quicker.” (Lefevre, 1923,1993) p.43.
“Every time I found the reason for a loss or the why and how of another mistake, I added a brand-new Don’t! to my schedule of assets.” (Lefevre, 1923,1993) p.70.
“If somebody had told me my method would not work, I nevertheless would have tried it out to make sure for myself, for when I am wrong only one thing convinces me of it, and that is, to lose money. And I am only right when I make money.” (Lefevre, 1923,1993) p.38.
“To learn that a man can make foolish plays for no reason whatever was a valuable lesson. It cost me millions to learn that another dangerous enemy to a trader is his susceptibility to the urgings of a magnetic personality when plausibly expressed by a brilliant mind. It has always seemed to me, however, that I might have learned my lesson quite as well if the cost had been only one million. But Fate does not always let you fix the tuition fee. She delivers the educational wallop and presents her own bill, knowing you have to pay it, no matter what the amount may be. Having learned what folly I was capable of I closed that particular incident. Percy Thomas went out of my life.” (Lefevre, 1923,1993) p.155.
These quotes exemplify an approach to life. Many people treat every failure as evidence that they just can’t succeed. The resilient investor will look at every mistake as a learning opportunity.
Proctor writes about John Templeton: “To some people such failures are regarded as defeat, whereas to others they have become challenges and opportunities to learn. John Templeton falls into this latter category.” (Proctor & Phillips, The Templeton Touch, 1983, 2012) p.122.
Lauren Templeton recalls when John Templeton decided to pursue an emerging markets strategy that included shorts. “However, after implementation we found that employing the necessary shorts was difficult since the emerging markets are not nearly as broad or deep as the U.S., and so we quit the strategy rather than plow deeper. He was quick to admit we had been wrong, and we simply moved on to the next idea. In that sense, he was a great experimenter or a tinkerer. He was always looking for new ideas and testing the ones he liked. When he found investment ideas that worked, he would focus on those and add more resources, and when he found a mistake, he simply moved on in methodical fashion and was not affected at all by the loss as far as I could tell.” (Proctor & Phillips, 1983, 2012) p.389.
Phillip Fisher, a major influence in Buffett’s approach to investing, wrote:
“Making some mistakes is as much an inherent cost of investing for major gains as making some bad loans is inevitable in even the best run and most profitable lending institution. The important thing is to recognize them as soon as possible, to understand their cause, and to learn how to keep from repeating the mistakes.” (Fisher, Common Stocks and Uncommon Profits and Other Writings. 1958,1996) p.276.
Relearning the same lesson
Of course, one of the toughest things is to periodically learn the same lesson over again. The lesson here is that we will often repeat mistakes. But that is simply Human. How often do we slap ourselves and self-talk that we have learned that lesson before? At such moments swearing is permitted.
The best time to learn a lesson from bitter experience is while the experience is fresh in our memory. What did we learn from the price rout in parts of our portfolio last year? Bad things happen all the time. The school of hard knocks is always open.
I would bore the reader to recite all my mistakes along the way that I have learned from. It would be useless anyway. Readers will only be able to learn from their own mistakes, not from mine.
Trial and error is a good way to describe the process, with emphasis on the error. We will always make errors. The key thing is what we learn from them. People are not born with superior investing judgment and investing expertise. Through reading and learning from our mistakes we can develop true expertise.
You can reach me by email at firstname.lastname@example.org
I’m also on Twitter @rodneylksmith
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