See part 1 here.
- The investment business is full of people who got famous by being right once in a row.
- One of the main reasons for this is the enormous influence of randomness. Events often fail to materialize as they should. Improbable things happen all the time, and things that are likely fail to happen. Investors who made seemingly logical decisions lose money, and others profit from unforeseeable windfalls. Nothing is more common than investors who were “right for the wrong reason” and vice versa.
- Investors would be wise to accept that they can’t see the macro future and restrict themselves to doing things that are within their power. These include gaining insight regarding companies, industries and securities; controlling emotion; and behaving in a contrarian and counter-cyclical manner.
- While we can’t see where we’re going, we ought to have a good sense for where we are. It’s possible to enhance investment results by making tactical decisions suited to the market climate. The most important is the choice between aggressiveness and defensiveness. These decisions can be made on the basis of observations regarding current conditions; they don’t require guesswork about the future.
- Superior results don’t come from buying high quality assets, but from buying assets – regardless of quality – for less than they’re worth. It’s essential to understand the difference between buying good things and buying things well.
- A low purchase price not only creates the potential for gain; it also limits downside risk. The bigger the discount from fair value, the greater the “margin of safety” an investment provides.
- The price of a security at a given point in time reflects the consensus of investors regarding its value. The big gains arise when the consensus turns out to have underestimated reality. To be able to take advantage of such divergences, you have to think in a way that departs from the consensus; you have to think different and better. This goal can be described as “second-level thinking” or “variant perception.”
- Over the last few decades, investors’ timeframes have shrunk. They’ve become obsessed with quarterly returns. In fact, technology now enables them to become distracted by returns on a daily basis, and even minute-by-minute. Thus one way to gain an advantage is by ignoring the “noise” created by the manic swings of others and focusing on the things that matter in the long term.
- Cyclical ups and downs don’t go on forever. But at the extremes, most investors act as if they will. This is a big part of the reason for bubbles and crashes. There are three stages to a bull market:• the first, when a few forward-looking people begin to believe
things will get better,
• the second, when most investors realize improvement is
actually underway, and
• the third, when everyone concludes that things can only get
- It’s important to practice “contrarian” behavior and do the opposite of what others do at the extremes. For example, the markets are riskiest when there’s a widespread belief that there’s no risk, since this makes investors feel it’s safe to do risky things. Thus we must sell when others are emboldened (and buy when they’re afraid).
- What the wise man does in the beginning, the fool does in the end. “First the innovator; then the imitator; then the idiot.” – Warren Buffett
- Every investment approach – even if skillfully applied – will run into environments for which it is ill-suited. That means even the best of investors will have periods of poor performance. Even if you’re correct in identifying a divergence of popular opinion from eventual reality, it can take a long time for price to converge with value, and it can require something that serves as a catalyst. In order to be able to stick with an approach or decision until it proves out, investors have to be able to weather periods when the results are embarrassing. This can be very difficult.
- Never forget the six-foot tall man who drowned crossing the stream that was five feet deep on average.