WHY AN INTELLIGENT INVESTOR KNOWS THAT GOOD INVESTING HURTS

WHY AN INTELLIGENT INVESTOR KNOWS THAT GOOD INVESTING HURTS

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Just like a Navy SEAL, the Intelligent Investor knows that good investing can hurt some of the time.

Okay, maybe a lot of the time.

Morgan Housel from the Motley Fool cites a study just conducted by Research Associates.

Of 350 mutual funds available to investors in 1970, only 100 survived through 2014. The other 250 closed, or were merged with other funds. Of the 100 that survived, 45 beat the market over the whole period; 42 of them beat it by less than two percentage points per year.

So what? Everyone knows that many mutual funds can’t consistently beat the market.

What’s remarkable is that the three “superstar” funds that did beat the market by more than 2 percentage points a year for 45 years, spent, on average, a third of the time underperforming the market on a rolling three-year basis.

Mutual Fund Performance INTELLIGENT INVESTOR

Source: Research Associates (click image to enlarge)

As Housel points out:

You can imagine the ridicule these managers went through when, for years on end, they lagged the market. Clients surely pulled money out of their funds. Journalists stopped calling them. Their personal pay likely plunged. It was uncomfortable. But they still beat 99% of their peers over the long run.

The same thing happened to Warren Buffett in the 1990’s, when everyone was getting themselves wrapped up in the dot-com craze.

Read: 5 Ways the Nasdaq is Different Now than 15 Years Ago

Buffett was widely chastised by analysts and the media throughout the late 90’s for not jumping aboard the internet train. People called him too old, too conservative, out-of-touch, and a has-been.

But Buffett (i) didn’t understand many of the new tech stocks, and he doesn’t invest in what he doesn’t understand, and (ii) saw the bubble being created by outlandish valuations (in March 2000, the P/E for the Nasdaq was a sky-high 175!).

After a heady experience of that kind, normally sensible people drift into behaviour akin to that of Cinderella at the ball. They know that overstaying the festivities… will eventually bring on pumpkins and mice.Warren Buffett, December 1999

To be sure, Buffett felt a lot of pain during this period, as he both underperformed the high-flying internet stocks and was ridiculed for doing so. His biography, The Snowball, even opens in July 1999 in the midst of this very drama.

But in the end, Buffett adhered to his Intelligent Investor principles, endured the pain, and had the last laugh.

Read: The Biggest Threat to Your Portfolio Today

What was the worst pain you ever felt while investing? How did you get through it? Tell us about it in the comments section!

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About the Author

VintageValueinvesting
Ben Graham, the father of value investing, wasn’t born in this century. Nor was he born in the last century. Benjamin Graham – born Benjamin Grossbaum – was born in London, England in 1894. He published the value investing bible Security Analysis in 1934, which was followed by the value investing New Testament The Intelligent Investor in 1949. Warren Buffett, the value investing messiah and Graham’s most famous and successful disciple, was born in 1930 and attended Graham’s classes at Columbia in 1950-51. And the not-so-prodigal son Charlie Munger even has Warren beat by six years – he was born in 1924. I’m not trying to give a history lesson here, but I find these dates very interesting. Value investing is an old strategy. It’s been around for a long time, long before the Capital Asset Pricing Model, long before the Black-Scholes Model, long before CLO’s, long before the founders of today’s hottest high-tech IPOs were even born. And yet people have very short term memories. Once a bull market gets some legs in it, the quest to get “the most money as quickly as possible” causes prices to get bid up. Human nature kicks in and dollar signs start appearing in people’s eyes. New methodologies are touted and fundamental principles are left in the rear view mirror. “Today is always the dawning of a new age. Things are different than they were yesterday. The world is changing and we must adapt.” Yes, all very true statements but the new and “fool-proof” methods and strategies and overleveraging and excess risk-taking only work when the economic environmental conditions allow them to work. Using the latest “fool-proof” investment strategy is like running around a thunderstorm with a lightning rod in your hand: if you’re unharmed after a while then it might seem like you’ve developed a method to avoid getting struck by lightning – but sooner or later you will get hit. And yet value investors are for the most part immune to the thunder and lightning. This isn’t at all to say that value investors never lose money, go bust, or suffer during recessions. However, by sticking to fundamentals and avoiding excessive risk-taking (i.e. dumb decisions), the collective value investor class seems to have much fewer examples of the spectacular crash-and-burn cases that often are found with investors’ who employ different strategies. As a result, value investors have historically outperformed other types of investors over the long term. And there is plenty of empirical evidence to back this up. Check this and this and this and this out. In fact, since 1926 value stocks have outperformed growth stocks by an average of four percentage points annually, according to the authoritative index compiled by finance professors Eugene Fama of the University of Chicago and Kenneth French of Dartmouth College. So, the value investing philosophy has endured for over 80 years and is the most consistently successful strategy that can be applied. And while hot stocks, over-leveraged portfolios, and the newest complicated financial strategies will come and go, making many wishful investors rich very quick and poor even quicker, value investing will quietly continue to help its adherents fatten their wallets. It will always endure and will always remain classically in fashion. In other words, value investing is vintage. Which explains half of this website’s name. As for the value part? The intention of this site is to explain, discuss, ask, learn, teach, and debate those topics and questions that I’ve always been most interested in, and hopefully that you’re most curious about, too. This includes: What is value investing? Value investing strategies Stock picks Company reviews Basic financial concepts Investor profiles Investment ideas Current events Economics Behavioral finance And, ultimately, ways to become a better investor I want to note the importance of the way I use value here. It’s not the simplistic definition of “low P/E” stocks that some financial services lazily use to classify investors, which the word “value” has recently morphed into meaning. To me, value investing equates to the term “Intelligent Investing,” as described by Ben Graham. Intelligent investing involves analyzing a company’s fundamentals and can be characterized by an intense focus on a stock’s price, it’s intrinsic value, and the very important ratio between the two. This is value investing as the term was originally meant to be used decades ago, and is the only way it should be used today. So without much further ado, it’s my very good honor to meet you and you may call me…

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