A Wealth of Common Sense

By Ben Carlson

Link to author’s webpage

One of the biggest advantages individuals have over the pros is the ability to be patient. No one is judging you against your peers. There is no one to impress. They are no style points when investing.

When buying individual stocks, people to tend to invest only in those companies that they are familiar with. They sell winners and hold losers, because of an anchoring to past prices. Instead of judging an investment by its current value, investors think in terms of the original price they paid and hope that it will someday get back to their cost value before they sell. (Gurjot’s note: this is an okay thing to do if you are not a full-time investor, i.e., if you’re doing it part-time, your mental health is more important so stick with stocks that you know a few things about; and if you have kept enough liquidity, hold a losing stock for longer periods before selling unless things have gone seriously wrong)

Philosophy first, strategy second and discipline third

If your portfolio is able to meet your goals, who cares if you beat the market or not?

  • Investors without a plan are the ones who will surely fail on a consistent basis because they’re constantly relying on their gut instincts to tell them what to do.
  • Your investment philosophy is much different than your portfolio or strategy. Your core beliefs should guide all future portfolio management decisions.
  • When designing your investment plan, systematic investing can be extremely beneficial if you are able to make good decisions up front and automate rational behaviour.
  • Successful investment philosophies and investors are always tested during difficult markets. Doubt will begin to seep in. Temptation to make changes to your process will slowly creep into your psyche. Defining yourself as an investor can help relieve this issue.
  • Of course, any long-term strategy can be emotionally draining at times. The trick is finding the one that balances your ability to sleep at night with a high probability of achieving your long-term financial aspirations.
  • Every investor should be able to explain their investment philosophy in a 60-second elevator pitch.

Keep your wits by yourself

Make sure you have a reason for everything you do in your portfolio.

  • It can be difficult for intelligent people to realise that success in one field doesn’t necessarily translate into market success.
  • Once investors feel they have a sense of control and certainty over the markets and assume they understand exactly how things work, trouble strikes.
  • It’s more important to reduce unforced errors than it is to get everything perfect.
  • Less is more and doing nothing can be exemplary behaviour, assuming it’s part of your plan. For many, doing something, anything, is much easier because it gives you the feeling of control.
  • Some investors constantly check the value of their portfolio. The more often you check your portfolio, the more likely it is that you’ll see losses. The markets are extremely random over the short term so doing this sets the investor up to take unnecessary actions. Or if no decisions are made, it uses up important willpower by resisting calls to action by the movements in the markets and the change in your portfolio’s value.
  • The biggest thing for investors is to understand what you own and why you own it.
  • The true diversification benefit of owning both stocks and bonds comes during the down years. Stocks are what you invest in to get rich, bonds are what you invest in to stay rich.
  • When things seem the worst, it’s actually the best time to invest. If you wait for things to get better, chances are the ship has already sailed.
  • The odds of consistently picking the best and worst days are minimal, but putting money into the markets on a periodic basis is something every investor can do. (Dollar-cost averaging)

Market behaviour

Your long-held beliefs about the markets will be called into question on a number of occasions throughout your lifetime.

  • The stock market is cyclical. Whatever happens in the stock market today has happened before and will happen again.
  • People control the stock market and those people sometime’s get together to make irrational decisions all at the same time.
  • The stock market and the economy are rarely in sync with one another. Economic growth tells us very little about where the stock market is going next.
  • The long-term average market performance is made up of many periods that are anything but average. Plan on experiencing uneven results, frustrating periods, volatility, and the occasional crash.
  • Financial market history can be useful in defining and managing risk, but it will never be able to tell you how to make the perfect move at the perfect time.

Handling risk

On paper, Buffett was down hundreds of millions or even billions of dollars, but he never locked in those losses by selling. Risk really only matters if it has a consequence attached to it, either through a liquidity event because you’re forced to sell or psychologically because you make a huge mistake at the wrong time.

  • One of the best forms of risk management is having enough liquid assets on hand so you aren’t forced to sell your risk assets (read: stocks) during market crashes or corrections.
  • One of the reasons stocks are able to earn higher returns for investors over time is because there are periods where you are able to buy at the much lower levels to boost your performance. Not many investors have the requisite intestinal fortitude to pull this off, which is why some investors to succeed while others fail.
  • Once you start to take the market’s movements personally, you have already lost. We have to invest in markets as they are, not as we wish them to be.