The key to successful investing is understanding that there isn’t a perfect solution, there isn’t an investment strategy that doesn’t have drawbacks, and no strategy will be immune to periods of under-performance.
At first this statement may seem like an oxymoron. After all, I’m saying that the key to successful investing is understanding that there isn’t a perfect solution. But hear me out. Once you understand that there isn’t a perfect solution and that there’s no magic recipe for market beating results all of the time, it will free you from the bondage of chasing every tip, strategy, or hot stock that happens to be performing well in the near term.
The only way I know of to be successful at investing is to develop a strategy and stick with it through thick and thin. There is no one size fits all solution here either. What works for me is to create a diversified portfolio of holdings, dedicating portions to holdings that work in a variety of different market environments (treasuries for deflation, growth stocks for risk on, high quality dividend and value stocks for the dull periods, etc.). This way there’s no need to try to predict every short term macro outcome each year (which is impossible anyways). My stock picking strategy is basically growth at a reasonable price. But there are a plethora of different strategies to choose from. You just need to understand your goals, time horizon and risk tolerance. And if you can’t do it yourself, find a competent advisor that can do it for you.
Let’s use the example of Warren Buffett since he’s the most famous investor of our time. Buffett’s Berkshire Hathaway is up over 1,000,000% from it’s beginning in 1964 to the 2015. Handily outperforming the S&P 500 (up 2,300%) over that same time frame. So by looking at this chart you’d assume that Buffett must beat the market all of the time right?
Actually this isn’t true at all. Per Bloomberg, Berkshire beats the S&P 500 51% of the time on a monthly basis, 55% of the time on a quarterly basis, and 67% of the time on a yearly basis. So in the short term it’s basically a coin flip and even on a yearly basis Berkshire under-performs the S&P one third of the time. The aggregate difference is so staggering because Buffett isn’t focused on beating the market but instead he focuses on his strategy and sticks with it through thick and thin.
So if the greatest investor of our time, with unlimited capital, fails to beat the market on an annual basis 1/3rd of the time, why do we think we can possibly do better? The problem is in the way we assess performance, focusing far too much on the short term. This leads investors to constantly change their strategy in a frantic search to find the perfect solution, when none exists. This search generates transaction costs, tax liabilities (if applicable), buying stocks/asset classes at highs, while selling stocks/asset classes low. In totality it usually causes more harm than good and once we accept this fact, the sooner we can move onto healthier investing behaviors and benchmark time horizons.
Now obviously this isn’t a truly fair comparison. Buffett basically operates a hedge fund and his insurance department of the business offers almost unlimited cash flow to buy more and more stock as it goes down. A luxury unfortunately very few of us will ever have. But the premise remains the same. The increased focus on annual returns has done more harm than good in my opinion. Personally I think performance stats on anything shorter than 5 years shouldn’t hold much weight. A typical full market cycle usually occurs in five years or so and that is how you truly judge performance.
Who cares whether you made 5% or 8% one year if you had to take on too much risk to achieve it and lose 50% of your account value during the next inevitable bear market. Who cares if your high dividend stock is paying 5% dividends instead of the 1.5% a treasury bond pays when your a conservative investor. That 3.5% isn’t going to make a difference when the stock drops 10% in one day anyway (something a treasury bond wouldn’t do).
Assess your goals in comparison to your risk tolerance and time horizon and use a strategy that best fits your comfort level and don’t look back. Don’t be tempted to deviate to the newest investing fad that’s flying high. You’ll do fine without it.
There is always a trade off between risk and reward in every legitimate investment. After seven years of solid gains in stocks, I worry that investors may have developed amnesia about where we came from, while being sidetracked by performance chasing. Usually investors get sucked into this game at the most inopportune times.