One question I keep getting asked is ‘what is the most important skill to have as an investor.’ Many people think the answer is something technical like great analytical or quantitative skills. But the answer is much more simple than that; in theory. The most important skill in my opinion is the ability to keep your emotions under control. The ability to keep your head in check when the world is going mad. The ability to think rationally.
All the great investors, from Buffet to Templeton to Munger to Klarman understand this and that is why they are truly great. In down markets, they keep their cool by not selling at the bottom. Instead, when everyone else is losing their heads, emotionally stable investors are thinking rationally and adding to their positions at beaten down prices. This is why Warren Buffet Says “ be fearful when others are greedy and be greedy when others are fearful.” Essentially, it means buy when everyone is selling and don’t get too excited at market tops. You don’t want to be the greater fool buying something at overvalued prices.
Be a Rational Investor
As an investor, the best strategy is to be rational. Rational investors are the best at exploiting inefficiencies which the market readily provides. They don’t get caught up in sudden market movements and don’t outsource their decision making to the herd on whether to buy, sell or hold a stock. They take their tie to consider the evidence at hand and work out whether the market is either right or wrong. They work out whether to be fearful or greedy.
Whilst keeping emotions in check and following basic investment principles of being quality companies with durable competitive advantages at decent valuations sounds easy in theory, it is much harder to do in the real world. This is due to the 2 powerful psychological forces of Fear and Greed.
In a bull market, people fall in to the trap pf becoming more and more greedy. They have a fear of missing out on the rally and will pile money in to the markets; usually at the top. We all know what happened during the dot-com bubble.
Have a look at the story of GTAT investors to see how pilling into a stock and getting too greedy can lead to financial destruction. The investors in GTAT stopped thinking rationally and instead went with there ‘gut feelings.’ They threw their investment thesis out of the window.
We are currently in a bull market that is 8 years strong. This is a timely reminder not to get too greedy. You need to look at the fundamentals of a company when buying stocks as opposed to blindly buying and and hoping a rising tide lifts all boats. This is why I prefer picking my own stocks as opposed to investing in passive index funds at this stage of the bull market (LINK).
The bottom line is don’t get caught up in market greed. Instead, hold cash (LINK) and take advantage of the buying opportunity fear brings.
When markets drop and bear markets kick in, people tend to do stupid things. Initially, when markets drop 10%-20%, most people would brush it off and correctly point out that this is a good opportunity to buy on the dips.
But when the stock market falls further, in the 30%, 40% and 50% ranges, people become panicked and gripped with fear. They get this fear of losing all their money and thus they can’t sell their stocks quick enough. Oddly enough, these people end up selling at the bottom and lose all the gains accumulated in previous years. These same people will then miss out on the beginning of the proceeding bull and will buy at the top.
When fear grips the market, it is often a great time to buy. Companies who are consistently growing their profits see their share prices drop for no reason. Quality companies become cheap. You shouldn’t be one of those people depressing the stock price by selling. You should be on the other side of the trade and buy. Your future self will not regret it.
Story of John Templeton – Buying When Fear kicks In
John Templeton was one of the greatest investors of all-time. He was a well-known value investor and a natural contrarian who was successful at buying during times of maximum pessimism.
Here’s one of his legendary investment tales via Business Week:
In 1939, when World War II began in Europe, the 26-year-old investor borrowed $10,000 and bought 100 shares each in 104 companies that were selling at $1 a share or less, including 34 in bankruptcy. A few years later, he made large profits on 100 of the companies; four turned out to be worthless.
The best investors are not only intelligent but they have seemingly complete control over their emotions.This allows them to go against the grain, but not just for the sake of being a contrarian. That doesn’t always work as not all investments come back from the dead. To be a truly great contrarian investor you have to look for value not just lower prices. Templeton was a master at finding value in the rubble.
Here are John Templeton’s 16 Rules for Investment Success:
1. Invest for maximum total real (after-inflation) return
2. Invest – don’t trade or speculate
3. Remain flexible and open-minded about types of investments
4. Buy low
5. When buying stocks, search for bargains among quality stocks
6. Buy value, not market trends or the economic outlook
7. Diversify. In stocks and bonds, as in much else, there is safety in numbers
8. Do your homework or hire wise experts to help you
9. Aggressively monitor your investments
10. Don’t panic
11. Learn from your mistakes
12. Begin with a prayer
13. Outperforming the market is a difficult task
14. An investor who has all the answers doesn’t even understand all the questions
15. There’s no free lunch
16. Do not be too fearful or negative too often
These rules actually first appeared in The Christian Science Monitor all the way back in 1933. And they are all still relevant today. That is the definition of timeless advice.