Six Tips for Investment Success

Investment success can be a tricky thing. Following considerable research on the subject (and the best research of all: risking my own capital!), I've compiled a few consistent themes here from highly successful money managers.

1) Humans aren’t wired for investment success. We get too carried away by fads and try to chase last year’s best performers. We take comfort in following the crowd when we need to be a contrarian, we get sucked into the hype no matter how much we know it not to be true, and invariably we get burned in the end. To block this out though is exceedingly difficult. Trends can persist for long periods of time and will smash even the greatest of skeptics. To “go against the grain” can be a lonely and unforgiving process. Only time will prove you right, and if you don’t have time (ie. A portfolio manager who needs to perform every year regardless) then you will get crushed. Those who succeed (Buffet for example) are likely more adept at blocking out the human emotion than they are at picking stock market winners (which of course is also important, and the combination of the two can lead to phenomenal returns).

2) History repeats itself. The stock market is a fickle beast, and goes through cycles over and over again. Stocks in certain sectors become overvalued, stay overvalued, and then become more overvalued as more people jump on board and come up with ever smarter and seemingly sound arguments as to why “it’s different this time” and why stocks will remain overvalued. (Or why investors build bigger and taller castles in the air). A hot IPO market is often a confirming indicator of a market top. Inevitably that nasty thing called mean reversion takes hold and brings the high-fliers back to earth, at which point everything gets crushed—growth, value, bonds, commodities, currencies—correlations all go to one in an extreme down market and there is nowhere to hide. Invariably the fall is faster and harder than the upward progression. Thus begins a period of rebuilding where people swear off stocks, which can persist for several years until the next new fad comes along and gets pumped up by Wall Street with similarly smart arguments as to why the fundamentals support a new rally in _______________ (insert new fad/trend here).

3) Keep your winners. Most people sell after a double or "triple-bagger". That’s great but doesn’t pay for the losers that drag down returns. You need the big wins to make money after compensating for the mistakes.

4) Only three outcomes of a trade are acceptable: i) big gain, ii) small gain or iii) small loss. NO big losses. Ever. Read this again until it sinks in. Taking big losses means there is a psychological barrier (in you) that needs to be fixed.

5) Get out of the quarterly grind. Too often we get caught up in the quarter by quarter focus on whether the company beat or missed expectations. Choose longer term themes that play out over many quarters or even years and don't get too hung up on the daily fluctuations in the stock price. Over the long term if your research is correct and a theme plays out as it should the stock price should move higher.

6) The market is a humbling place. It can humble even the most astute investment pros and shake the confidence of the most stalwart investors. As George Soros said, “The job of the market is to fool people”.

There are countless other gems but these are just a few of the common themes.

As an aside, I can say that after last year (2008) I am skeptical of investment "pros" offering investment advice as to how to be successful in the markets. Much of this as we know is time and place - those who made a bullish call on equities in the 80s and held the position to somewhere in the mid 2000s look like superstars. After last year however, these same pros gave back much of the gains, such that their five and ten year returns were in many cases modest to negative (an 80% loss in one year applies to ALL prior gains, such that you only have 20% of your money at the end of the year and most people who got in within the last few years are virtually wiped out). 2022 Update: This comment continues to ring true after the retracement of so many high fliers. Beware of bull-market geniuses dispensing investment advice.

However, in forming my own definition of investment success I figure that anyone capable of generating double digit returns over a 10 year period or more is worthy of taking note. During that time frame there would have been likely one or more market corrections, fads, trends or other themes that played out. Ten years is also a good round number for professional success, as a portfolio manager capable of generating strong returns over ten years (ie. say 35 years old to 45 years old, or 40 years old to 50 years old, etc) will be able to write his/her own ticket. And to grow personal net worth, one doesn't need many ten year stretches of 20%+ returns to build some decent wealth. For example, $100,000 compounded over 10 years at 25% is about $750,000, over 12 years is $1.2 million. Even $50,000 at 25% a year is $1.1 million in 15 years. Thus stick to people who have been there, done that, so to speak. Do it once and presumably you can do it again. These are people I have time for. The rest is merely noise!

Be sure to check out my post Stop Counting Turkeys for more on this subject!

And check out this post for a recommendation on what I think is the all-time best article on investing! (but don't be fooled by its simplicity) All-Time Best Investing Article