*This article was origionally published on the CFA Institute's Enterprising Investor blog.
All great investors have one thing in common: the “ability to clearly communicate their [investment] philosophy,” Michael Batnick, CFA, observed.
I agree. Whether hedge fund managers, value investors, or index aficionados, the best investment professionals are great communicators.
But great investors, no matter their investing styles, share one other quality: the discipline to adhere to their investment approach through various market cycles.
Great investing is not simply a matter of identifying The Best™ investment strategy. In the 1990s, James O’Shaughnessy documented a variety of effective strategies in What Works on Wall Street. A number of approaches work, however, the key is not so much to find them, but to apply them with consistency.
Meb Faber, CIO of Cambria Investments, put it like this:
“The reason [Warren] Buffett is successful is not because he has a magic stock wand, but rather has unbelievable ability to stick to his style. There are numerous investment styles on Wall Street that work — value, momentum, trend, buy and hold — they all work. The challenge is sticking to your style and not selling at the worst time.”
According to Faber, Buffett’s stock picks “would have done over 9% a year and would have beaten about 98% of all stock mutual funds in the United States” from 2000–2015. But beating all but 2% of funds comes with a price: Buffett’s picks trailed US stocks seven out of the last nine years. It obviously takes a lot of discipline not to deviate from that strategy.
As Buffett said, “Successful investing takes time, discipline and patience. No matter how great the talent or effort, some things just take time: You can’t produce a baby in one month by getting nine women pregnant.”
Investing is cyclical, which makes adhering to one approach all the more difficult. Because we tend to overemphasize recent history, the temptation is to extrapolate current events well into the future. The urge to switch to the best-performing strategy — the current fad — is perennial, even if the cyclical nature of the markets will undoubtedly bring that strategy down to earth before long.
Howard Marks, CFA, wrote about the self possession required for successful investing over the long term in The Most Important Thing:
“I think it’s essential to remember that just about everything is cyclical. There’s little I’m certain of, but these things are true: Cycles always prevail eventually. Nothing goes in one direction forever. Trees don’t grow to the sky. Few things go to zero. And there’s little that’s as dangerous for investor health as insistence on extrapolating today’s events into the future.”
Jack Bogle echoed these thoughts in The Clash of the Cultures: “The most important of these rules is the first one: the eternal law of reversion to the mean (RTM) in the financial markets.”
Typically, the temptation to abandon our strategy is greatest when we feel greed, envy, or fear. When we see another strategy outperforming ours, we suffer from the fear of missing out (FOMO). Anxiety works the same way: When the markets drop, we remember what we used to have, not what got us there. But Bogle’s advice remains: No matter how greedy or fearful we are, stick with the strategy.
So if different investment strategies can work as long they are consistently applied, how do we know which one to pursue? Here it comes down to our interest, skills, and, most notably, knowing ourselves. Some strategies outperform but go through long periods of underperformance or deep drawdowns. These are difficult for all but the most-disciplined investor to adhere to. Buy and hold works for many, but some investors require a tactical risk-management component to help ride out market downturns.
Edward Thorp, a great investor and clear communicator, had this to say about playing to our strengths:
“Try to figure out what your skill set is and apply that to the markets. If you are really good at accounting, you might be good as a value investor. If you are strong in computers and math, you might do best with a quantitative approach.”
Clifford S. Asness made this observation about matching our strategy and time frames: “Essentially, a disciplined approach to value and momentum are both good long-term strategies, but you don’t want to be a momentum investor at a value time horizon.”
The best investors in the world pursue strategies that suit their skills and emotional strengths. This gives them the “unbelievable ability” to see those strategies through.
All this isn’t to say that our approach should never flex or adapt to a changing world. Buffett famously altered his strategy from a deep value focus to one favoring companies with strong moats (i.e., long-term competitive advantages) after connecting with Charlie Munger. But this change occurred progressively over time, and was not the result of jumping on the bandwagon of a hot strategy.
But whatever their investment philosophy, successful investors all share that one key trait. It comes down to discipline, to the determination to choose a viable strategy and stick with it.
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