A Dozen Things I have Learned from Barry Ritholtz about Investing
by Guest Author - May
8th, 2015, 9:00am
Tren Griffin runs 25IQ, a blog about business models,
investing, technology, and other aspects of life that he find interesting.
He works for Microsoft; Previously he was a partner at Eagle River, a
private equity firm established by Craig McCaw.
~~~
A Dozen Things I have Learned from Barry
Ritholtz about Investing
As part
of my “A Dozen Things I’ve Learned” series of blog posts I thought I would take
on a list put together by Barry Ritholtz. My self-assigned task is to add my
support to what Barry wrote, while staying with
my usual 999 word limit for any given blog post. The task I assigned to myself
is to elaborate on what he has written (rather than just repeating what Barry
wrote) since the best support for the investing maxims themselves comes from
Barry himself. Given Barry’s towering intellect, this is a scary exercise.
1. “Cut your losers short and let your winners run.” Loss
aversion is highly dysfunctional for investors since it causes people to hold
on to “losers” for too long to avoid the pain of a loss. The first half of
Barry’s first maxim pushes against that aspect of loss aversion. Cutting losses
short pushed against a tendency to hold tightly to losers hoping that they
recover before then need to acknowledge the loss. The second half of Barry’s
first maxim helps lower transactions costs, fees and taxes, but is also about
the value of opportunity cost analysis. Charlie Munger once put it this way:
“There is this company in an emerging market that was presented to Warren. His
response was, ‘I don’t feel more comfortable buying that than I do of adding to
Wells Fargo.’ He was using that as his opportunity cost. No one can tell me why
I shouldn’t buy more Wells Fargo.”
2. “Avoid predictions and forecasts.” The less
complex the system you are trying to understand, the greater the likelihood you
can make a bet which is both non-consensus and correct. Making a bet which
follows the consensus and it correct will only deliver beta. The most complex
system of all is the macro economy since it is composed of a nest of complex
adaptive systems rife with both uncertainty (probabilities unknown) and
ignorance (probabilities not computable). On a relative basis, the most
tractable system on which one can make an investment and try to generate alpha
is an individual company. Very few people can make non- consensus bets which
are also correct at a company level, but its is at least possibl;e if you are
smart and work hard. 90%+ of people are better off buying a low fee index even
when it comes to making bets on individual companies. The greatest for
investors often comes from the fact that 70% of people think they fall withion
the 10% who can generate alpha. When it comes to self-appraisals humans are too
often vastly over generous.
3. “Understand crowd behavior.” Humans
often herd. People like what others like (path dependence) and especially in
the presence of uncertainty or a requirement that they actually do some work,
will follow other people. Most notably when diversity of opinion breaks down,
crowds are often *not* wise. Buying when others are fearful and selling when
others are greedy. is wise.
4. “Think like a contrarian (occasionally).” As I
noted in my post about Howard Marks, you
must both adopt a view that is contrarian *and* be right to outperform the
market. Being a contrarian for its own sake is a ticket to losses since the
crowd is often right.
5 . “Asset allocation is crucial.” The
amount you allocate to each investing category is a more important decision
than the individual assets you pick within that category. My thoughts on asset
allocation for muppets are here: Giving advice
to “know something investors” is something I have not yet tackled since they
are know-something investors already (seems like bringing coals to Newcastle).
6. “Decide if you are an active or passive investor.” My
thoughts on active vs. passive are here: As Dirty Harry
said to the cornered criminal in the movie Magnum Force: ”A man’s got to know
his limitations.” “I feel lucky” is not the way a genuine investor conducts his
or her affairs.
7. “Understand your own psychological make up.” As Feynman
famously said, the easiest person to fool is yourself. Genuine self-knowledge
is hard-won knowledge since no one has perspective on yourself by definition.
On this topic it is wise to read Charlie Munger.
8. “Admit when you are wrong.” Heuristics
like “public commitment consistency” bias cause us to hold on to positions long
after a reasonable analysis by a neutral observer would have concluded that we
were wrong. For example, once you say publicly “X is going up” it gives your
brain a shot of stupid juice when it comes to concluding that you might be
wrong.
9. “Understand the cycles of the financial world.” Barry
seems in agreement with Howard Marks on this point. Nothing good or bad goes on forever. As Billy
Preston sings in the well-known song things “go round in circles.” Mr. Market
is bipolar and for that reason market swings will always happen. By focusing on
the intrinsic value of individual investments And tuning out the talking heads
blathering about their macroeconomic forecasts, market swings can become your
friend. The irony is: the more you focus on what is micro in nature, the more
you will benefit from macro trends.
10. “Be intellectually curious.” It is in
“the micro and the obscure” where one can learn things which others do not
know. To make a bet that is contrary to the consensus of the crowd you must
possess knowledge that the consensus has not adopted. You will mostly likely
find that non-consensus knowledge on the frontiers of your own knowledge.
Really great investors read constantly and actively seek out alternative
viewpoints. Shutting out views you disagree with is a step toward an echo
chamber.
11. “Reduce investing friction.” John
Bogle formed Vanguard on the basis of the “cost matters hypothesis” not the
efficient market hypothesis. On that you might want to read. Paying high fees,
costs and commissions is one of the simplest investing errors to correct.
12. “There is no free lunch.” There is
no substitute for hard work and rational decision making.
~~~
Originally published at September 2013
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