Insights

Warren Buffett, one of the most successful investors, once shared his recipe for becoming wealthy: “I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.” This simple yet profound advice holds valuable insights for investors seeking long-term success in the market.

Many investors and investment consultants spend considerable effort identifying top-performing investment managers, hoping to find those with a Midas touch. However, history has shown that these managers often underperform after periods of strong performance. Much as life itself, everything goes through cycles, as do investment strategies and fund managers. These cycles’ inevitable ups and downs lead to emotional reactions among investors, resulting in selling during painful periods and buying when outcomes are favorable. Unfortunately, this pro-cyclical behavior negatively impacts investment results more than the positive gains from the best fund managers.

The chart below depicts the performance of various asset classes over twenty years and the returns of the average equity and fixed-income investor. The data reported by Dalbar in its Quantitative Analysis of Investor Behavior (QAIB) study illustrates that the average investor’s return was significantly lower than that of stocks (S&P 500) and bonds during this period.

The key to achieving superior investment outcomes lies in a simple truth: increase allocations to assets priced below their estimated value and decrease allocations to assets priced above their estimated value. Baron Rothschild expressed it vividly, “Buy when there’s blood in the streets, even if the blood is your own.”

So how to do it? How do we, as investors, put together a process that yields superior investment results? As Charlie Munger said, “You need patience, discipline, and an ability to take losses and adversity without going crazy.” Within this statement lies the essence of successful investing.

1. Patience. Patience is one of the most essential ingredients for successful investing. You need it both when awaiting investment opportunities and after acquiring an investment. Paul Samuelson put it best: “Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.”
2. The Investment Discipline. When constructing an investment portfolio, there are two primary questions that the investor needs to answer, what to buy or sell and when.
   • Answering the what question. The decision of what to buy or sell is related to the concept of Circle of Competence – the simple yet powerful idea that you should stick to those businesses and investments you understand well. As Mr. Buffett stated in his 1996 letter to shareholders of Berkshire, “You don’t have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.”
   • Answering the when question. The central concept driving the decision of when to act is Margin of Safety. Once you have determined what to invest in, the key to superior outcomes is straightforward: buy when others are fearful and sell when others are greedy. In a portfolio construct, this means increasing allocations to assets with wider margins of safety and reducing allocations to assets with low margins of safety.
3. Philosophical perspective. A philosophical perspective is paramount in weathering the ups and downs of the market. As Mr. Munger emphasized, you must be able to handle losses and adversity without losing your composure. It is crucial to differentiate between what we can control and what we cannot. We can control the businesses we invest in and the prices we pay for them, but we cannot control the prices that markets assign to those businesses.

So, there we have the secret to investment riches. Simple, yes. However, it is far from easy. Indeed, it is one of the hardest things to implement because the behavioral actions needed are the opposite of how most people think and act. If you find yourself cringing and unable to bear the pain during periods of large market declines, be mindful. In such a case, the appropriate thing to do is to identify the kind of investment advisors who do not depict those same characteristics, have uncompromisable integrity, and do not overcharge for their services. Conduct detailed due diligence in selecting them and then follow it up with regular verification checks – do so when you are not affected by your behavioral compulsions.