Unconventional wisdom: Too many investors are following an incoherent strategy
Investors are cherry-picking different investing maxims to justify doing whatever they want, whenever they want.
Conventional wisdom is a byproduct of groupthink that presents solutions good enough for the average person while simultaneously not being right for any individual. You follow it at your peril. The more different you are from the person that defined a rule the less you should follow the rule. Each Monday I will challenge the investing norms that just may be holding you back from living the life you want.
Unconventional wisdom: Too many investors are following an incoherent strategy
“Borrowed wisdom can be vicious. I need to make a huge effort not to be swayed by well-sounding remarks. I remind myself of Einstein’s remark that common sense is nothing but a collection of misconceptions acquired by age eighteen.”
- Nassim Taleb
I’ve been traveling in India and one of the many great things about this wonderful country is thali. Thali is a tray with several small dishes. You might get a curry, some dhal, a little okra, rice and a raita. It is a great way to try a wide variety of dishes. And the best part is you can have more of anything - or more of everything.
A thali is a good analogy for the way many people are investing these days. People are plucking parts of different investing theories and weaving them together. With a thali there might be some dishes that go very well together and the point is to mix and match. But if you dumped all the little bowls onto the tray and mixed them up you would be left with a mess.
It is possible to merge different investing theories into a coherent personal strategy to achieve your goals. However, there are some investing theories and approaches that just can’t go together because they are fundamentally inconsistent.
My observation is that many investors are simply cherry-picking different maxims to justify doing whatever they want, whenever they want. That isn’t a roadmap for successful outcomes.
Why it is important to have a strategy
Having an investment strategy provides structure around decision making. This structure can be criteria for which investments to buy or sell in your portfolio. It can be a blueprint for how you will react to different market environments.
Attaching that strategy to your goals and personal investing philosophy personalises your approach and ensures it is designed to achieve what you want out of life.
I could write a book on why this is a critical component of success. But the summary is that investing is hard. It is easy to be overwhelmed by choice and noise. Successful investing is not about following your instinct. It is about following a plan.
Lessons from the greats
Two of the most popular investors to look to for wisdom are Warren Buffett and John Bogle. They both revolutionised investing in very different ways.
Warren Buffett took the foundational teaching of Ben Graham on fundamental analysis and added some wisdom from Phil Fisher and Charlie Munger to create his own approach.
John Bogle introduced passive investing which changed the way millions of people invest and brought many positive changes to the investment industry.
They are both giants in the investment world but their approaches are very different. Warren Buffett is an active investor looking to exploit mispriced assets. All those pithy Buffett quotes that everyone likes – be greedy when others are fearful, etc. – are all about actively managing your portfolio.
John Bogle was not a proponent of passive investments. He was a proponent of passive investing. The ‘passive’ part describes what you do as an investor. And what you do is nothing. You pick an asset allocation and maintain it with additional contributions and rebalancing. That is it.
These two approaches to managing your portfolio are fundamentally in opposition. You can’t invest like Buffett and Bogle. Yet many investors don’t stop there. They want a little more excitement.
Adding a bit of short-term trading to the mix
Buffett’s approach to active management is long-term. Famously his aim is a holding period of ‘forever’. Most investors like talking about long-term investing far more than they like doing it. The way most people invest more closely resembles Jesse Livermore who was the basis of the book Reminiscences of a stock operator.
Livermore was a proponent of technical analysis. Technical analysis is predicting future price movements using past price movements. It is fundamentally in opposition to Buffett’s approach of ignoring price and focusing on valuation. Technical analysis couldn’t be further from Bogle’s passive approach.
Thinking short-term while pretending to be a long-term investor and espousing the principles of Buffett and Bogle is a ridiculous proposition. Yet this is what many people are doing.
An incoherent investment approach
Wide numbers of investors have merged these three investment approaches together. Investor cash is flowing into passive ETFs. Yet investors are not investing passively even as they praise Bogle’s views on active management.
Frequently trading passive ETFs is a sign that investors don’t trust professionals to pick individual shares but they do trust themselves to pick the right time to invest. And how do they justify trying to time the market? By citing Warren Buffett of course.
Warren Buffett is a proponent of buying shares when they are cheap. Yet to determine if they are cheap he performs a deep fundamental analysis to assess individual businesses. This is hard to do and most investors don’t even try.
What I’m observing is that many investors are simply substituting price movements – and relatively minor ones – for valuation. What do you call using price as a signal to make buy and sell decisions? That is technical analysis and market timing.
What has happened over the last few weeks in this round of Trump turbulence highlights the investing approach of actively managing portfolios using passive investments with price as the trigger for decision making. That is ‘buying the dip’.
How investors are hurting themselves
Investing doesn’t have to be dogmatic. Arguments about who adheres better to some school of investing thought are silly. The goal for all of us is to earn a high enough return to enable a better life. As an income investor I hear lots of commentary on how unsophisticated my approach is. I’m not here to preach or to judge.
I have the same instincts and temptations. I have moments when I feel I have more insight into short-term market movements than I do. I remember the times I was right - even if by dumb luck - and lament the profits I missed. I tend to quickly forget the times I was wrong. In short, I’m human. I’m just trying to improve the way I invest and hopefully help some readers do the same.
The whole point of defining an investing strategy is to provide structure to decision making. A coherent and well-defined strategy provides ballast in the emotional turbulence of market movements.
The problem with an approach that allows freedom to do anything at any time is the complete lack of structure. It is a formula to follow your instincts or ‘advice’ from somebody with different goals and objectives. That is not a formula for success.
Final thoughts
There are many ways to be a successful investor. The key is finding the approach that works for you and is aligned with what you want to achieve out of life. My concerns with the way many people invest has nothing to do with it being different from my own approach. My concern is that I don’t think it works.
The evidence suggests that most investors not only don’t beat the market but also fail to earn a return that is higher than a term deposit. Dalbar and J.P. Morgan looked at the average performance of individual investors in the US between 1998 and 2017. They estimated that the average investor achieved a 2.60% return per year.
To avoid this fate I would suggest writing down your investment strategy. Outline the criteria you use to determine if a certain security is worth buying. Describe how you decide if you should sell something from your portfolio.
Your investment strategy doesn’t have to be complicated but you should capture the rationale for each part of it.
For instance, if your strategy is to invest more if the market drops 10% document why this is a more attractive option than simply investing every time you save some money. Write down in what scenarios your strategy won’t work.
The simple act of writing things down will cause you to be more thoughtful about your strategy. Seeing something on paper will also improve your strategy because you are more likely to catch any inconsistencies with your approach.
I think we would all benefit from a little more structure – especially at a time like this. I would love to hear your thoughts. Email me at mark.lamonica1@morningstar.com
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What i’ve been eating
Laal maas is a mutton curry that is a specialty of Rajasthani cuisine. The secret to a Laal maas is the Mathania chillies which come from a small village outside of Jodhpur. While chillies are used in much of Indian cooking they are not native to the country. The Portuguese explorer Vasco De Gama was said to introduce chillies to India from Mexico and they didn’t reach northern India until the 1700s when the Marathas warriors from southern India helped to overthrow the Mughal Empire. I enjoyed the pictured version at Indique restaurant in Jodhpur looking up at the magnificent Mehrangarh Fort.
