Here I’m talking about a serious amateur investing, that is, a process of independent portfolio building by a person that is not working in the field of finance and is looking to own asset classes besides cash.
- It takes a lot of studying
In order to reap a return on your investment, you need to understand many things. They include your personality (we’ll talk about this again later), the investing mindset, the basic arithmetic and probability skills to deal with numbers, the types of asset you want to invest in and their characteristics, and the assets you want to invest in (e. g. which company or which government bond). For a particular company you should understand the business model, assess their financial well-being, assess their position in the market, and assess their future potential. After all, if you hold a share of a company, you literally own a piece of that company (I keep this in mind all the time. I ask, “do I want to own the entire company for at least ten years?” If the answer is no, most probably I shouldn’t want to own a piece of it for a week or two as well).In order to understand all this, you need to know the financial language and accounting knowledge. And the financial world is big and things are interrelated to each other. The nature of the relationships is either dynamic or unknown or complicated or all of the above. Oh, and you need to know how the economy works or at least the basic concepts (supply and demand, interest rates, etc). Yet knowing these and trying to fit things in do not necessarily guarantee success (related to my fifth point). Bonus difficulty: knowing the history of the particular industry you’re interested to invest in (e.g. technology — knowing the rise and fall of technologies and how a company’s success depends on… so many things… will help you in making some decisions).This initial stage takes a lot of patience and effort (if this point turns you off then probably you can stop reading here). But worry not, because there are a lot of resources to learn from (which brings me to the second hard truth). For some knowledge in probability, accounting and economy, there are a lot of free MOOC on accounting provided by Coursera, eDX, etc.
What do we do about it? One needs a strong motivation to get through the truckload of information (I went through hundreds of webpages, a handful of books, and pages of annual reports learning all these, and I’m far, far away from being done). One example of motivation is wanting to get rich (which will be discussed more in the third point). You may also be a lover of numbers and analytical thinking who just loves the process of investing without caring how much money it earns you (like how Warren Buffett “tap dances to work” for he loves what he does so much).
- It gets really confusing
Years ago there were only a handful of sources of financial news. Then Internet happened. It gets easier to start a website and many start doing so and handing out many pieces of advice (exactly what I’m doing right now, although I won’t say this is a piece of advice at all). The pieces of advice vary in quality in terms of accuracy, clarity, and completeness among other things. Worse still, they often contradict each other (e.g. to time the market or not to time the market? The folks who say timing the market is stupid always tell you to invest during crisis though?!). So you don’t know which one is right. Then there’s the jargon. Then there’s quoting of the same famous investors (either Warren Buffett or the Oracle of Omaha. Wait they’re the same person) who say and do things that seem to be contradicting. Why is that so?In the case of Warren Buffett, he is now in his eighties. He has had a long career and despite his huge success, made mistakes along the way (like buying that Berkshire Hathaway that is almost synonymous to his name right now) and learned from them. Furthermore, he has always been in the situation that is very different from us retail investors. So the things he does are often not feasible for many of us at this stage and are different from the folksy, deceivingly simple pieces of advice he gives. I think he’s like the Enlightened One of investing who says simple-sounding things like Buddhist aphorisms (e.g. “Peace comes from within. Don’t seek it without”). They’re simple, but it takes at least half your lifetime to really get it.What do we do about this confusion? I’d say it takes an attitude similar to that needed for other things in life. This attitude is… not simple and not easy to practice. I try to practice the following: know yourself (it’s a never-ending process of understanding what suits you), know the biases that affect your decisions, be open-minded, question everything (the motive of the advice giver, the wording of the advice, the nature of the asset, etc), quantify everything if possible (this is a contestable, dangerous point), be patient, write down concepts in order to visualize them and make them clear, read books by reputable investors who share timeless, not daily, wisdom.
- It takes a lot of patience
Warren Buffett said once “my favourite holding period is forever”. He’s considered to be the best investor in the world and of course you want to learn from the best. If you read about other great investors, they play the long game too (at least 10 years of holding period). So, besides the patience and effort needed for studying, and the patience and (intellectually intense) effort needed to sift through the confusion, there has to be the patience to see the result. It’s not a get rich quick scheme at all. If anything, it’s a get rich slowly scheme (then why on earth do people invest?). And after so much patience, you may not see result (which is discussed in the fifth point).What do we do about it? I think there are various ways to cope with your impatience. One is to tell yourself that this is your retirement saving and you’ll be well-rewarded for this (which may not always be the case). Two is to buy and forget. Don’t check your broker account obsessively to see whether you’ve gained in a day (unlikely). Do so much due diligence before deciding to buy, that you can afford to forget that there’s something in your account, and one day in ten years you may see that the tiny seeds you planted have turned into a plantation (I’m exaggerating here, but it happened to those who invested in Buffett’s company before it got big).
- It takes a lot of internal chill pills
The Oracle of Omaha and many other investors say that it takes average intelligence to be able to succeed in investing, but it takes extraordinary ability to not let feelings interfere with your decisions (but then, the Oracle is an extraordinarily intelligent person, so again, he’s probably being contradictory again). One example of feeling interfering with decision is buying a company because you love the product (e.g. maybe you loved Blackberry and BBM so much). Another example which is more commonplace is when you see the market going up and down on a crazy roller coaster ride, which is almost all the time. The media outlets make it worse by putting headlines like “The Richest Guy in Asia Loses $3.6 billions in the Market Rout” or “IMF: Global Market Should Brace for China Slowdown” (“Oh no! Oh no! Sell now!”)What do we do about this? Benjamin Graham (the Oracle’s teacher) created a character called Mr Market to teach investors about this. Mr Market is a manic depressive guy who comes to you daily to tell you the prices. When they’re high he’s really ecstatic and enthusiastic in telling you, making you want to buy. When they’re low he’s depressed as hell. But the good thing is there’s no obligation for you to buy, no matter what his mood is. You get to decide. You just shouldn’t ever be affected by his mood in making your decision.
- Solutions to points no. 1 to 4 do not always work, and results may not show
Points no. 1 and no. 2 are intellectual matters: they’re about studying (both the technical aspects and the mindsets) and making sense of the information overload. As said above, it’s a wide, wild world. And there are shenanigans in accounting and along Wall Street. You may not know these things. You may be so busy in life that you have no time to educate yourself. You may not want to know some things (e.g. I’m not that interested in studying about investing in tobacco companies because I don’t want to invest in them).But this is not something to be very sorry about. Even the best don’t know everything. They know what they don’t know, and they say that’s the beginning of their mastery. They identify their circle of competence and stick to them (said Charlie Munger, Buffett’s crazy smart but low profile partner, who, again, is probably being contradictory on the surface, because he loves learning about diverse topics and not sticking to his things. But deep reading of his writing helps me reconcile the two seemingly contradicting actions).The starting point is to start. Start reading. Start talking to knowledgeable people (who doesn’t have any conflict of interest with you) . Even if you decide not to invest at all, this knowledge helps you understand a little about how the human world works, and a little understanding goes a long way in unexpected ways (e.g. better answers when being interviewed, better decisions when economic crisis strikes, etc)Points no. 3 and no. 4 are emotional matters: they’re about controlling your emotions and cognitive biases, preventing them from influencing your decisions. We are all humans with much feels that get intense at times. We make mistakes. Fatal ones.The starting point is to know yourself in an objective manner, in the sense that you’re not overestimating or underestimating yourself. A good example is found in Tim Ferriss’ Rethinking Investing. He knows he has to be in control of what he’s investing in and he can’t take the possibility of buying or selling anytime which leads him to invest in startups that lock him for at least 7 to 10 years instead of investing in common stocks that keep him awake at night thinking of whether to buy more or not. Buffett knows that he’s good at assessing business model and the management, and that he and Munger love the idea of “deserved trust” so he buys companies with good business model and good people and “sit on their asses”. Walter Schloss knew that he’s better at numbers than at assessing people. So he chose to assess companies through numbers (CNAV method).
Some people know for sure they just can’t handle points 1 to 4 and prefer keeping cash instead. That’s a respectable decision which has an advantage in times of recession where cash relatively holds on to its value.
The next thing you can do if you’re serious about investing is seriously learning to control emotions. Some people get the ability as a side effect of activities they do such as serious sports they’re involved in (Kyle Bass and his free-diving hobby) or meditations (e.g. Bridgewater’s Ray Dalio). You can start practising these or exploring other activities.
Even after you get points no. 1 to 4 right, you may make mistakes. After all it’s a complex world full of unknown and dynamic and complex and random things and relationships between things. Well, every decision comes with a risk including the most mundane decisions. Investing takes a different kind of leap of faith, and risk that can be quantified.
What can you do about this?
I don’t want to be conclusive because when one is being conclusive, one often overlooks other important things. But it seems like it all comes down to risk management. To quote Benjamin Graham, the three most important words in investing are “margin of safety”. In short:
- You identify the risk (In this case you may lose money and your peace of mind)
- Identify the reward (Is the reward even worth the risk? You may be rewarded with comfortable retirement. Do you think it’s worth the headache and the loss of sleep?)
- Assess the vulnerability (What will be affected? Your whole life saving or just a fraction of it? Your ability to go vacation next year or your kids’ education?)
- Determine the risk (How likely is that company you’re planning to invest in to go bust in the next five years? How many hundreds or thousands of dollars will you lose if that happens?)
- Identify the way to reduce the risk (Solutions to points 1 to 4: general and specific due diligence and emotion control are what the professional investors do to “beat the market”)
- Prioritize risk reduction (Which step comes first?)