Being a successful investor is not hard but it is more difficult than it looks.
What makes it more difficult is not acquiring the mental skills you need. Accounting and basic mathematics can be learned by anyone.
What makes it difficult is the emotional or behavioural skills you need. The difficulty in mastering these skills is that the wrong approach is hard wired into our brains, making it very difficult to take the correct action.
Here are my 6 indispensable traits for investment success
1. The ability to seek and buy undervalued securities
At first glance this seems easy but it is not. Ignoring companies with upwards rocketing share prices while looking companies those share prices are hitting new lows is not easy.
An November 2009 example would have been ignoring companies like Amazon (PE = 71) and Apple (PE = 31) and looking at telecommunications companies like Vivendi (PE = 8.8) and other solid companies left behind in the current rally.
This trait will result in you not being able to talk about your portfolio at cocktail parties because after mentioning your investments you will either get a blank stare or asked if you are mad and do not read the newspaper?
I am immediately self excluded from hot stock conversations at cocktail parties – this is a trait of all successful investors!
It does not bother me in the least as I invest to make money not to have something to talk about at social gatherings.
2. The ability to stick to your investment process
Even the most time tested investment processes underperforms in some years. In fact studies have shown that they can under-perform for up to three to four years.
It is the reason why Joel Greenblatt says that, in spite of the spectacular success of his magic formula, so many people will not start using the formula, thereby reducing its effectiveness.
If you follow a time tested investment process and it is under-performing, by all means re-evaluate the reasons why it is under-performing, but be very careful before changing it. You may be changing at exactly the wrong time.
Think of the value investors that started investing in internet stocks just before the internet technology bubble burst.
3. The willingness to learn from past mistakes
This is also harder than it sounds, even for the most successful investors.
Losing money on an investment is a painful experience.
However working through your past mistakes provides the perfect opportunity to see where you went wrong and improve your investment process.
My best example is in 2007 my largest position Lambert Howarth went into administration. It was not so much the complete loss that hurt my performance it was the fact that I allowed the position to become a too large a position in my portfolio. Especially for such a small company.
I keep an investment diary where I write a short note on the reasons for buying as selling an investment and I have also started keeping track of investment after I sold them, so that I can compare my sell decision with the share price performance thereafter.
I review both on a half yearly basis.
4. Have the courage of your conviction
Once you have gone through your company valuation process and completed you analysis it is time to put your money on the table and invest.
If the share price is moving against the market hitting new lows it is of course a reason to be careful, and a reason to make sure you have not overlooked something, but if not it is time to invest.
Irrespective of what friends, colleagues or other investors may thinking or doing.
Because of my fear that it will get even worse, I missed the March 2009 lows and did not invest. That was in spite of me watching companies I have already analysed fall to ridiculously low prices. I am talking of price to earnings ratios of less than four.
I watched the companies drop to price earning ratios of four and even two and still did not buy. But I learned from that experience, made changes to my investment process and I think I will be able to buy when it happens next time.
Believe me it will.
5. Have a system for managing risk
Risk management is not rocket science.
But you have to think of what your tolerance for risk is, write it down, and implement it as part of your portfolio management.
Things you have to think about:
- That is the maximum percentage of your portfolio you want to invest in one company? Mine is 4% as I want a minimum diversification if 25 names in my portfolio.
- Will you follow a strict stop loss system? For example sell at a 16% to 20% loss irrespective of what has happened. I have developed a semi-rigid system that works for me based on valuation and portfolio weighting. Its a bit too complicated to explain here but it will be part of a future newsletter.
- What percentage of your portfolio will you invest in one industry? I have a rule of about 20% but its not something I apply rigorously.
- If you use multiple investment strategies do you have a limit as to that percentage of your portfolio should be invested in each. For example if you follow a low price earnings strategy what is the maximum percentage you will allow to have room for other strategies such as low price to book companies? I do not have any limit with regards to any strategy.
6. Have the courage to sell
This point may seem obvious but it is not. I have fallen in love with a good performing company only to see the share price decline after reaching a new high and a high valuation.
I am sure you know the feeling.
In order to avoid this happening I re-evaluate the companies in my portfolio soon after the release of interim or annual results to see if there are any fully or overvalued positions that have to be sold.
I also have a system in place where I review a position after an increase of 50% and 100%.
Usually however this problem takes care of itself. I do not like having more than 30 companies in my portfolio. Should I thus want to add a new position I have to decide what position to sell before the new company can be added.
This process results in new undervalued positions being added to my portfolio all the while at the same time getting rid of over or fully valued positions.
Also remember, the lowest risk profits in any investment is made when a company moves from being undervalued to fairly valued, as this is the time when you have the largest margin of safety.
Holding a security with the expectation that it will move up in price from fairly valued to highly or overvalued is risky as downside protection i.e. the amount of undervaluation is gone.
I learned the above traits over the 30+ years I have been active in investing. Some were learned with financial losses, something I hope I can help you avoid.
Investing is not rocket science. It has more to do with common sense than most people realise.
If you have answered the important questions and have a system in place to take care of the ups and downs you can be certain of acceptable investment returns over time.