Author - Prashant Vaishampayan

Ravichand on his blog writes about how winners bet selectively. The Question that investor face – Do you chase many mediocre opportunities in the market and bet frequently or search for a few great opportunities and bet selectively?

In the absence of a crisis, great investing ideas/opportunities are very rare and you generally get one or two of them in a year. Many good ideas can only be a poor substitute for a single great idea. Yet we want some “action” in the market every single day and many times we end up placing bets on even moderately good ideas. Why?

 The possible reasons: Need for “action” or seen doing something;  No one is sure when the next great opportunity will come and/or how big it will be;  Professional fund management compulsions; Sitting on Cash on the sidelines without swinging your bat is nerve-wracking;  Not many have the luxury to sit all day long “reading” (working)

Quoting Buffett is a cliché but many times it’s the most appropriate. If you think that you would need a large number of investing bets because you have a big corpus then spare a minute to have a look at Warren Buffets investments in marketable securities. Around 87% of his USD 173 billion worth investments at the end of 2018 were concentrated in just 15 securities. By betting selectively on a few great ideas, Buffett has made a fortune.

The research study also highlighted this fact that investing only on our high conviction ideas and consciously avoiding mediocre lower conviction ideas will do wonders to our portfolio returns and our investing career.

5 C’s of selective betting

 Competence: The skill required to find great ideas. You cannot become a great Pastry chef if you don’t know how to bake. Similarly, if you are going to bet selectively on great ideas then you should first be competent enough to identify one.

Cash: Adequate Funds to back the great ideas What is the use of a great idea if it cannot be backed by adequate funds. Allocate too little and you cannot really feel the impact. Allocate too much and your portfolio can get wiped off. Always back great ideas with materially significant allocation which is neither too little or too much

Conviction: High confidence in your idea When you bet, place your stakes on an idea on which you have the highest conviction. The one which you believe has the best chance of success backed by research, data and thought. Betting selectively in great ideas only requires a bundle of confidence. Confidence is needed in your investing process, in your investing strategy and most importantly in – YOURSELF

Courage: Courage in times of crisis. Great opportunities come usually when there is a crisis or what you say as “when there is blood on the street”. There could be great opportunities when outstanding companies are going through a temporary problem. Courage to back up your great ideas during a crisis is priceless.

Character: Ability to say “No” Last but certainly the most important “C” is your “character” – your basic nature, trait and mental make-up. Similarly, for an investor, the ability to say “No” is a tremendous advantage. When your friends and colleagues are caught in the market frenzy, maintaining a Zen level of calmness and not biting at every cookie thrown at you requires a great temperament. Sitting on cash without hitting the buy requires character.

This post is part of a series on The Virtuous Investor written by Joachim Klement. Let’s face it, we all make mistakes, both as investors and in our lives. There is no shame in making mistakes, but there is shame in not wanting to get better at whatever you strive to do. If you want to be a great painter, you better paint as many paintings as you can. The first few are likely going to be rubbish, but over time, your skills will develop, and you will get better at it. Does that mean you are going to be the next Leonardo da Vinci or Pablo Picasso? Probably not, because these painters had an exceptional amount of talent that only very few people have. But that talent needed to be exercised and practised before it could come to full fruition.

What is true for artists is true for investors as well. We all have to practice investing in order to get better. And just like most artists never will be as good as Leonardo, so too will most investors never be as good as Warren Buffett. But you can at least strive to become the best investor you can be. There is one crucial difference between artists and investors. While we can choose to become an artist or not, everyone is forced to become an investor, whether they like it or not.

The practice is a necessity for investors, but unfortunately, practice is only half the ticket to better returns. The other half is to learn from past mistakes. And unfortunately, this is where most investors fail miserably. As investors, we tend to forget our past mistakes and remember our past successes.

The virtuous investor is aware of this faulty financial memory and uses techniques to record investment decisions and learn from mistakes. The simplest technique Klement knows of and uses are investment diaries. In an investment diary, you record every investment decision you make with three short bullet points:

1. What decision did I make?
2. Why do I think this investment is going to make money?
3. What could go wrong?

These three bullet points in your investment diary give you a picture of your thinking. After a while (and Klement recommends doing this regularly) you can review past decisions and your thinking at the time. This way, you will start to understand where you made mistakes in your investment decisions and learn to avoid these mistakes over time. Klement admits that it is a long and tedious process that will improve your investment performance only gradually, but as with almost all things in life, there are no shortcuts.

Becoming a good investor not only takes years of practice, it takes years of deliberate practice which means not just doing things, but systematically reviewing past actions to learn from past mistakes and build on past successes.

Ian Cassel writes that an investor learns from hindsight and get paid for foresight. Often times an opportunity exists because the conditions aren’t perfect yet. Investor has to pull the trigger in advance of all the pieces coming together. Investment success is determined by two things: First, How well you assimilate imperfect information and Second, Your ability to identify when you are wrong quicker.  

Jeff Bezos of Amazon said the following about decision making. Cassel thinks that it is the perfect description of investing: “Most decisions should probably be made with somewhere around 70% of the information you wish you had. If you wait for 90%, in most cases, you’re probably being slow. Plus, either way, you need to be good at quickly recognizing and correcting bad decisions. If you’re good at course correcting, being wrong may be less costly than you think, whereas being slow is going to be expensive for sure.”

The price of certainty is expensive because it slows you down. We want to know everything. If I just knew a little more. A little more. A little more. But knowing more often times breeds confidence but not accuracy. 

Cassel thinks if Bezos would have continued his quote he would have said focus on the 70% that matters and be okay if the 30% you don’t know hurts you. You have to live with the possibility that you could be wrong. You can’t let the fear of the 30% steal your courage to move forward if you believe the odds are in your favor. 

How can you be both quick and accurate?  Cassel applies four filters to every new company he evaluates: An organization with signs of intelligent fanaticism; A business that can grow through a recession; A balance sheet that can weather a storm and act with occasional boldness; A stock that can conservatively double in 3 years.

When Cassel applies these four filters he might miss something, but it cuts to the core of what is important. He can normally size up a new opportunity that he is attracted to in a few hours. Over the years Cassel found being quick has served better than being slow. If it takes a long time to get to a buy decision then it probably isn’t a buy. The great opportunities are normally obvious, at least to an investor.

In addition, Cassel found buying small and averaging up later as you gain additional conviction is a great way to counterbalance being fast and right with the risk of being fast and wrong. You aren’t going to be right all the time, but try to be wrong as fast as you can and move on. 

“Be willing to make decisions. That’s the most important quality of a good leader. Don’t fall victim to what I call the “ready-aim-aim-aim-aim” syndrome. You must be willing to fire.” – T. Boone Pickens

Jon writes about this on his blog https://novelinvestor.com/. He quotes Stan Druckenmiller “Every great money manager I’ve ever met, all they want to talk about is their mistakes. There’s great humility there.”

Investing is just a long series of decisions where some end in gains and others end in losses. If you’re doing it right, the gains outweigh the losses in the end, hopefully, by a large enough margin that your goals are reasonably satisfied. In other words, every investor makes mistakes. Those that don’t are lying. That’s the uncomfortable truth. Those that go on to be great investors, learn this through experience…and apparently love to talk about it. So what’s the benefit of constantly talking about their mistakes? For one, they embrace the inevitable.

Peter Bernstein writes about the importance of this realization and why it matters: The trick is not to be the hottest stock-picker, the winningest forecaster, or the developer of the neatest model; such victories are transient. The trick is to survive! Performing that trick requires a strong stomach for being wrong because we are all going to be wrong more often then we expect. The future is not ours to know. But it helps to know that being wrong is inevitable and normal, not some terrible tragedy, not some awful failing in reasoning, not even bad luck in most instances. Being wrong comes with the franchise of an activity whose outcome depends on an unknown future. The nature of uncertainty in the process makes being wrong inevitable because not only will you make mistakes, you can make the right decision and still lose money. So are you prepared for it? Survival is about planning for the inevitable losses in advance.

Following a few basic investing principles help with this.

Ben Graham introduced the idea of margin of safety decades ago as a way to embrace mistakes from the start. It’s as simple as leave room for error. He believed the possibility of being wrong should be factored into the price you pay for an investment. The idea is to pay a low enough price, so even if you’re wrong, you only lose a little. In general, survival is the only road to riches. Let me say that again: Survival is the only road to riches… The riskiest moment is when you’re right. That’s when you’re in the most trouble because you tend to overstay the good decisions.

When you combine it with diversification — spreading your money across multiple investments — if one turns out bad, it won’t be devastating.  That’s what diversification is for. It’s an explicit recognition of ignorance. And I view diversification not only as a survival strategy but as an aggressive strategy because the next windfall might come from a surprising place. You reap further benefits when you diversify. If some investments inevitably turn out worse than expected, the opposite could happen to others — some turn out better. In other words, you get unexpected opportunities. Not a bad consolation prize for survival.

Dan Mikulskis asks us on his blog realreturn.blog what really matters most in the volatile, uncertain and ambiguous environment of investing. Is it Better earnings models? More research? Using skilled managers? Access to deals? These things can and do matter, and fortunes have sure been made promoting these ideas. But for the majority of end investors, it’s often more fundamental (and basic) wisdom that has a bigger impact. There aren’t any secrets, some of the best advice is simple, but not easy.

Direct Attention: The world is noisy and our attention easily distracted to the wrong things, this can be bad. There’s always another macro forecast, a piece of economic data, a political event or an under-performing manager to take our attention. Most of this doesn’t matter in the big picture. Be intentional.

Measure what Matters: Returns, risk, and progress toward your objectives. Don’t get drawn into all the rest of the weeds too often. Be wary of measures turning into targets that aren’t fully aligned with your outcomes.

Accept Responsibility: The decisions you take will have an important impact on outcomes, but it takes a lot of work to rid decision of bias. Avoid the table-pounding guru with sweeping powers. Reward dissent, be accountable, divide & conquer, be truth-seeking, deploy diversity well. Warren Buffet says “The people who know the edge of their own competency are safe, those who don’t, aren’t”

Prepare for Uncertainty: The future will not evolve in nice straight lines as much as we might wish it to. You will lose money at some point and you will be unsure of what to do. Prepare in advance for these moments and manage your own future expectations. Pre-commit. Set yourself up to react confidently to both good and bad news. Peter Bernstein reminds us that the most important thing about risk is the ability to make decisions under uncertainty.

Vanguard Research recently published a paper on how to assess the value of financial advice. They mention that the global demand for high-quality, cost-effective financial advice is growing. In many countries, increasing reliance on defined contribution systems means more households will be retiring with substantial savings and will need affordable and effective help in managing them. More broadly, the financial services industry faces rising demand to improve client outcomes and value for money. How should investors measure the value of financial advisory services provided?

Vanguard suggests a three-dimensional approach. Investors should evaluate the adviser’s services in three areas.

Portfolio value. The first dimension concerns the portfolio designed for the investor. Value comes from building a well-diversified portfolio that generates better after-tax risk-adjusted returns net of all fees, suitably matched to the client’s risk tolerance. Portfolio value can be quantified in many ways, including different measures of portfolio risk-adjusted return, diversification and allocation metrics (such as active/passive share), the impact of taxes, and portfolio fees.

Financial value. The second dimension assesses an investor’s ability to achieve the desired goal. A portfolio does not stand on its own. It is in service to one or more financial goals, such as retirement, growth of wealth, bequests, education funding, and liquidity reserves. One way to evaluate success is to estimate the probability of achieving a financial goal or wealth target at the end of a specified period. Ultimately, an advisor should seek to improve an investor’s chance of achieving his or her desired future spending goal. To do this, the advisor must consider a myriad of planning-related metrics that extend beyond portfolio outcomes. These include financial behaviours such as optimal savings and spending; the assumption of debt; budgeting; insurance and risk management; various elements of tax-efficient retirement planning; and legacy, bequest, and estate planning.

Emotional value. The third dimension is an emotional one: financial well-being or peace of mind. The value of advice cannot be assessed by purely quantitative measures. It also has a subjective or qualitative aspect based on the client’s emotional relationship with the advisor. Underlying elements include trust in advisor, the investor’s own sense of confidence, the investor’s perception of success or accomplishment in financial affairs, and the nature of behavioural coaching such as hand-holding in periods of market volatility.

I believe that most of the times investors are overly focused on returns and cost of service (portfolio value) and overlook the other two (financial and emotional value) until it is too late.  

John Huber writes about the risk of outsourcing thinking in an update on his blog. There is a famous sociological experiment from the 1950s where 75% of the participants denied completely obvious facts that were right in front of their eyes simply because they were told that the rest of their peers chose a different (incorrect) answer. There are many reasons why many financial frauds occur, but Huber thinks one of the main reasons the frauds became so big and lasted so long is that investors primarily relied on the opinions of others. The fact that so many other smart people had already given the company their stamp of approval led to massive outsourcing of original thought. No real due diligence was performed by this investor group. If they had, they would have likely discovered numerous warning signs.

Huber gives one example each of independent thinking and outsourced thinking. During the last financial crisis in September 2008, Ken Lewis (CEO of Bank of America) hired two different banks to provide him with a fairness opinion so that he could buy Merrill Lynch. Lewis badly wanted to buy Merrill. The banks he hired to value Merrill knew this. And those two banks dutifully performed their job, giving Lewis the value he needed to justify the acquisition. So, on the Sunday of the epic “Lehman weekend”, Bank of America decided to pay $50 billion for a company whose equity would have most likely been worthless just two or three days later.

Earlier in the summer, Warren Buffett got a call from Dick Fuld (CEO of Lehman Brothers) late on a Friday evening. Fuld wanted Buffett to invest fresh capital into Lehman. This was before the crisis was in full force, but Lehman was starting to haemorrhage cash and was clearly struggling to survive. Buffett told Fuld he would think about it over the weekend. That same night, Buffett pulled out Lehman’s annual report required by the U.S. Securities and Exchange Commission (SEC) that gives a comprehensive summary of a company’s financial performance and began reading it, making notes in the margin. After a couple of hours, he put the filing down and called Fuld back and told him he wasn’t interested. There was simply too much about Lehman’s books that he didn’t understand and couldn’t figure out, and so he found it too risky and quickly decided to pass. He came to this conclusion on his own after reading a document that was publicly available.

Buffett didn’t make calls to Berkshire CEO’s in the finance industry, he sent no analysts to talk to bankers on Wall Street, and he certainly didn’t read any third party research. He simply pulled up a filing that any one of us could have accessed, and decided to see if the company was worth investing in. One guy outsourced his thinking, and one guy did the thinking for himself.

Huber’s observation is that independent thought is extremely rare, which makes it very valuable. On the other hand, outsourced thinking appears to be pervasive in the investment community, and because of how we’re wired, this dynamic is unlikely to change. Regardless of how convincing the facts are, we are just more comfortable if we can mould our opinion around the opinion of others. Understanding this reality and being aware of our own human tendencies is probably a necessary condition for investment success in the long run.

Vishal Khandelwal in his recent blog post reminds investors to ask themselves this question. He quotes Rework by Jason Fried. You don’t make a great museum by putting all the art in the world into a single room. That’s a warehouse. What makes a museum great is the stuff that’s not on the walls. Someone says no … There is an editing process. There’s a lot more stuff off the walls than on the walls. The best is a sub-sub-subset of all the possibilities. “It’s the stuff you leave out that matters,” writes Jason in Rework.

When you apply this crucial lesson to building your stock portfolio, it means that you are likely to succeed as an investor not just by the stocks you own, but more importantly by the ones you don’t. But often, we end up building warehouses of our portfolios, not curated museums. A stock is followed by another, then another, two more, three more, and on, and on, and on. Some people even maintain multiple portfolios, and each looks like a zoo of mismanaged, rowdy animals.

People buy stocks for all kind of reasons – they like them, their neighbours like them, their friends are making money on them, someone on Twitter is shouting about them, their prices have risen sharply in past few months, someone recommended them on TV, someone wrote about them on online forums, someone is boasting about them on WhatsApp groups, etc.

Investing follows life, and this is also what a lot of investors end up doing. They create crowded warehouses of portfolios in the initial years of their investment careers, realize most of their choices were mistakes, and then they start subtracting vigorously.

Lest you lose out on the positive compounding timeframe, you will do yourself a world of good by respecting and practising this lesson – of saying no to most things, of not adding a lot of unwanted stocks to your portfolios – early.

Khandelwal concludes by asking investors to be a curator of stocks, not a warehouse manager.

Dated: 27th July 2019

I came across this article written by Jeremy where he talks about that we have four currencies, four things we can use, invest, manage, and exchange. They are our Time, our Money, our Energy, and our Ability. The classical understanding of stewardship also is similar in defining stewardship as the management of our time, talent, and treasures. The balances of these currencies fluctuate with life’s seasons for each of us.

What’s interesting about these currencies is that they don’t exist in a vacuum. They’re interrelated. Each one requires varying degrees of effort to manage, and each one can negatively or positively impact another.

Jeremy’s point is that as humans in general, and investors specifically, we’ve got a whole lot more to manage than just our Money. And it is an ongoing management plan – things change, sometimes really quickly.

If you find yourself getting stuck, it’s super helpful to step back and look at the currencies of your life and see which, if any, are running low. And then think about ways you can try and bring it back up, even if it means dipping into another currency’s present excess.

The easiest currency to focus on is Money. Money is, arguably, the most renewable of the four. It’s also the most flexible – it can be used to buy more time, gain more energy, and build more Abilities. And that increase in Time, Energy, and Ability can then be used to acquire more Money if we’d like them to.

Jeremy thinks a reason why we talk and focus so much on money is that it’s the most concrete, and it’s the easiest one to measure. And it’s a good starting point, but don’t stop there.

If we want to live a life that manifests our true values – our true goals and intentions – we need to pay attention to all the currencies and manage them wisely.

Source: https://calibratingcapital.com/

Dated: 14th July 2019

Morgan Housel reminds us that Investing skills are important, but they have to be paired with personal finance skills to be sustainable.

Housel is surprised how many good investors he knows with terrible personal finance habits. Maybe he shouldn’t – they are completely different skills. The ability to uncover an undervalued investment is not associated with your propensity to avoid lifestyle bloat. The irony is that people who will move mountains to gain a few basis points of return bleed ten times that amount on personal spending that all science says adds little to their net life happiness.

But investing and personal finance rely on each other because few industries are as cyclical as investing and as Charlie Munger says, “The first rule of compounding is to never interrupt it unnecessarily.” Compounding works only to the extent that your lifestyle doesn’t force you to sell investments at inopportune times to fund your lifestyle. Someone earning average but uninterrupted returns may be better off than someone outperforming by 50 basis points a year yet forced to liquidate a portion during every bear market to pay off lenders.

Investment returns have a lot of potentials to make you rich and achieve your goals. But whether a strategy will work, and how long it will work for, and whether markets will cooperate, is always a question. Personal savings and frugality – finance’s conservation and efficiency – are parts of the money equation that are largely in your control and have a 100% chance at being as effective in the future as they are today. So which should you pay more attention to?

This is not about living like a monk, hampered by frugality. It holds true at every level of wealth and spending. Housel concludes that the idea that reducing your needs has the same impact as increasing your income – but the former is more certain and in your control than the latter, so it has a higher expected value – is as true for someone spending Rs15,000 a year as it is someone spending Rs15 lakhs per year.