Investing isn’t easy. Superior skill and extra-ordinary nerve are required to achieve above average results in investing.
Buffett claims gleefully that in investing, odds are stacked in your favor. While factually he is right, he may be making it sound too simple. That could lay a trap for lay investors. Charlie Munger is more forthright and candid when he says, “It is not supposed to be easy; anyone who finds it easy is stupid”.
Complexity arises from the inherent contradictions. Let us look at some of them as eloquently elucidated by Howard Marks in his memo in 2015:
- If one is defensive, portfolio significantly underperforms if market rises sharply.
- On the other hand, aggressiveness helps in a rising market, but hurts when market falls.
- If the portfolio is concentrated, mistakes will hurt deep.
- If the portfolio is too diverse, the pay-off from success will be limited.
- Leverage if deployed will magnify one’s mistakes when wrong and vice-versa.
Add to these, the challenges that come frequently while deploying cash in a falling market. After holding cash for a reasonably long time while the market kept rising, when the market turns and cracks, it will be tempting to quickly deploy when valuation turns attractive. If the market undershoots further, as it normally does, depleting cash too quickly tempted by attractive valuation could hurt the portfolio. Alternatively, if the market bounces quickly without undershooting further, decision to deploy quickly could prove to be a genius one. Both are possible outcomes in any market ( irrespective of the economic fundamentals at that point of time) depending on to what extent the fear cycle plays in the given point of time.
Our own recent experience has a lot to offer on what makes investing so hard. At the top of the markets in Nov-Dec, we did sense froth in the broader markets and decided to prune positions to raise cash levels to 20%+. Going by the extent of subsequent fall in Jan-Feb, in hindsight, one could argue that was not an aggressive cut in positions, though pruning did help in widening out-performance. The inter-play of fear cycle and the market swings make decision making very complex and challenging. Fear of missing out (FOMO) in the bull cycle and Fear of further fall (FOFF) in the down-turn create a havoc on the rationality that results in unpredictable movements in the markets, mostly manic in nature.
The next logical question is what can make investing less harder. While there is no magical silver bullet, there is a way to make it less complex. Value investing and the concept of Margin of Safety can come to the rescue. Following a decision making process based on Intrinsic value with target price based on Margin of Safety can make it more objective and thus less complex. That is probably the reason why Buffett said that the most important three words in investment business are “Margin Of Safety”. This process, though more objective and less complex, is not without its challenges. The hard part here comes more from the need for emotional efficiency. Developing emotional qualities (such as listed below) that bring this efficiency may sound simple, yet takes good part of lifetime to harness:
- Ability to digest short-term quotational losses
- Nerve to act in a falling markets
- Discipline to remain restraint in the rising market (and preserving cash)
- To retain objectivity in an irrational market setting
- Driven by neither greed nor fear
- To retain contrarian streak and not to get influenced by herd behavior
- Focus on Process, not on Proceeds.
For superior results in investing, there are no short-cuts. To quote from Howard Marks memo, “So, in the end, there is only one absolute truth about investing. Charlie is right : It isn’t easy”
Happy Value Investing!
ArunaGiri . N