Today marks 30 years since a confident young man walked into the back office of Schroder Investment Management in London, to start his first day on the job, the first in his career. Ask me a question back then and I would have answered assuredly and quickly. Today I’d be more likely to say ‘I don’t know’ with just as much confidence.
Now older, wiser, but with just as much hair, I have over the years seen many people come and go. Clients, colleagues, bosses, company mergers, bankruptcies (thankfully not my own), through bull and bear markets, booms, crashes, and have seen my own fortunes fluctuate too before setting out on my own a few years ago.
Thirty years is a long time. The good news is it was all worth it.
The first thing to point out is I don’t have all the answers. That’s not what this post is about. I’m always learning. But I have benefited enormously from people sharing their time and expertise, so if I can help others in the same way, I’m happy to share what I’ve learnt also.
These are 30 observations, guiding principles, or simply things that work for me. Some of you who have followed me for a while will recognise many of them. These aren’t universal truths, they’re my truths, my beliefs, shaped by my experience.
And that’s probably a good place to start.
“The more you believe something to be true, the more you will have accumulated evidence to support it.”
That’s a quote from trading coach Van Tharp, and I’ve applied it to so many areas as a simple way of explaining people’s expression of their beliefs, my own, and the realisation of how powerful confirmation bias is. Van believes we don’t trade the markets, we trade our beliefs in the market. A trading system therefore is simply a set of beliefs, and I think he’s right.
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The heady Indian bull market was fueled by the liquidity rush post demonetization. But that was not the only reason propelling indices in India to new highs. Thanks to lower global interest rates, money was channelized into India in the hunt for better returns. A stable government at the center, lower crude prices and low inflation were other factors that contributed to the overall positive sentiment.
But many of us wanted more than what blue chips had to offer. We wanted to “beat the market”. Or, for that matter even the track records of legendary investors like Warren Buffet or Peter Lynch. Naturally, this led us to scenarios which offered potentially superior returns. And in the perpetual hunt for 10-baggers, we ended up investing in nano-, micro- and small-cap companies with questionable business models, corporate governance and promoter intentions.
We looked at:
- Turn around stories
- Hope stories
- High growth small cap names
- Formalization of informal sector across industries
- Commodity stocks
Many stocks that fell in the above categorizations turned out to be 10-20 baggers over the last 3-4 years. But once the music stopped, we witnessed a vertical decline in stock prices that has stunned even seasoned investors.
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Before I really knew anything about human behaviour, incentives, and how the markets really work, I was always blown away by the sheer amount of intelligence I would come across in the investment world.
Most of the people I’ve interacted with throughout my career are highly educated at some of the best colleges and universities in the world. Many continued their education by getting advanced degrees or prestigious industry designations. They can speak eloquently, hit you with reams of data, can sell a ketchup popsicle to a person wearing white gloves, and have the utmost confidence in their own abilities.
After a few years of being impressed by the sophistication and above average IQ of the various portfolio managers, strategists, analysts, and marketing people I came into contact with, I finally had a realization – intelligence can only take you so far in this world. I didn’t exactly have an epiphany on the topic, but over time the shine began to wear off.
It became apparent that the smartest person in the room isn’t always right. In fact, most of the time their intelligence works against them because they’ve become so sure of themselves and their investing abilities that they’re unable to change their mind or accept the fact that the markets don’t care what your IQ is.
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Over the course of 15 years working as a performance coach with traders and investors, from day trading shops to hedge funds and investment banks, I’ve enjoyed an unusual front row on the factors that contribute to success and failure in financial markets. During that time, I’ve conducted numerous interviews, directly observed hundreds of traders and administered countless personality tests. That experience has convinced me that much of what we think we know about trading success is just plain wrong. In this article, I tackle three myths of trading success and offer alternate perspectives.
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If you question how ‘boring’ can be beautiful, you have been following the wrong investment strategy.
Too many people have the misconception that investing is glamorous. The reality is that glamour is the last thing you will find in the stock market, most especially if you plan on being successful.
Hedge fund guru, George Soros sums it up brilliantly: “If investing is entertaining, if you’re having fun, you’re probably not making any money. Good investing is boring.”
Sure, we have all heard of a stock market success story or two. You probably have an acquaintance who made a decent return from investing in a tech stock that tripled in price before selling. Maybe even someone who inadvertently timed the 2008-09 crash correctly. In most cases, these successes are short-lived and can be attributed to pure luck. Although these ‘successful investing’ stories make for good dinner-party conversation, they are by far the exception among prosperous independent investors.
The fact is investors who produce the flashiest returns, time and time again, usually do so in the most unglamorous manner. A great example is Warren Buffett, who built an empire investing in so-called ‘boring’ stocks.
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Value investing starts with low PE stocks, but it shouldn’t be an investor’s only financial metric.
What do Warren Buffett, Ben Graham, Seth Klarman, and Peter Lynch all have in common? Besides being wildly successful investors, they’re all are adherents to value investing, a method where one attempts to buy securities that have a higher intrinsic value than their current price.
One of the most basic forms of value investing is to find stocks with low price-to-earnings (PE) ratios. The PE ratio is a simple ratio that divides the current price per share of a company by the earnings per share over the trailing-12-month period. The logic behind buying low PE stocks is simple: As an investor, you are ultimately entitled to a pro-rata portion of company earnings, so paying the lowest cost, or multiple, for those earnings is preferable than paying a higher multiple. Essentially, your dollar is buying a larger portion of company earnings than it would with a high-multiple stock.
Investing is a difficult business and that’s why most people under-perform the market. That said, here are three common mistakes novice investors make all the time and how to avoid them.
1) They Chase Price:
People do not fully understand the way the market works. The biggest lesson novice investors should learn is that the market is counter-intuitive in nature. The second biggest lesson is that successful investors separate price from value. A common mistake novice investors make all the time is that they tend to chase price rather than make decisions based on the underlying fundamentals.
2) They Confuse Price With Value
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During three separate interviews this week I was asked if I was seeing any signs of complacency among investors, markets, or clients.
If anything, the people I talk to are more concerned with the high probability of lower market returns in the future but my view is surely clouded by the clientele and readers I deal with on a regular basis.Whether my sample size is representative or not, measuring market sentiment is getting harder and harder these days. Everyone now has a megaphone to voice their opinions — social media, blogs, 24-hour financial television, podcasts, conferences, magazines, financial news websites, etc.I don’t see how you can reliably track sentiment when it comes at you every day like a wave that changes form and shape depending on people’s mood that day. There’s just not much signal in all of the noise anymore.Of course, investors have been given plenty of excuses to be complacent. It feels as though volatility and bear markets have been outlawed in 2017 and stocks in the U.S. haven’t seen a down year since 2008.Since I don’t see any reliable way to track the potential complacency of investors as a whole, I tend to look at different ways investors can be complacent depending on which type of market environment we’re in.For example, last month I read the Schroders Global Investors Study which surveyed over twenty thousand investors from around the globe to get their expected portfolio returns over the coming 5 years. The results show this group was a tad ambitious: Investors expect an annual return of 10.2% on their investments over the next five years, according to a major new study.The Schroders Global Investor Study (GIS) 2017, which surveyed 22,100 people from around the globe who invest, found millennials even more optimistic. Those born between 1982 and 1999 expected their money to make average returns of 11.7% a year between now and 2022.Older generations were more realistic. The Baby Boomer generation – born in the two decades after the Second World War – anticipated 8.6% a year.Millennials (born 1982-1999, aged 18-35): 11.7% Generation X (born 1965-1981, aged 36-52): 9.8% Baby Boomers (born 1945-1964, aged 53-72): 8.6% Silent Generation (born 1923-1944, aged 73+): 8.1%Double-digit annual returns over the next 5 years from current valuation and interest rate levels seems like a stretch to me. I could be wrong but investors with such lofty expectations after we just went through a period of above-average returns (at least in the U.S.) seems to be somewhat complacent to me.Here’s another example (although this is more delusional than complacent):
When we find an attractive stock to invest in, we outlay money, aka invest, to earn an attractive return and the investment will involve a degree of risk.
One of the most dangerous, commonly accepted and ill thought out concepts in investing is the risk / return trade off.
That is: high returns equals high risk.
Unfortunately, Investopedia continues to spread this type dogma, as you can see by the graph below.
Volatility (standard deviation) is not risk!
The appropriate definition of risk is from the Oxford dictionary (or any other branded non-financial dictionary) as: Exposure (someone or something valued) to danger, harm, or loss.
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