Value Investing – 80/20 Principle In Action
“The few things that work fantastically well should be identified, cultivated, nurtured, and multiplied.” - Richard Koch
I woke up in a daze — it almost felt like I was upside-down….
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At that moment, an odd sense of weightlessness came over my body. I thought to myself, “maybe I was just dreaming.”
As I finally ‘came to’, blood was running down my face. It was at that moment I realized I WAS upside down. At this point, all I could think about was getting out before the car envelops into flames.
With blurred vision, I looked over at the passenger seat, not having remembered if anyone had been in the car with me. Thank goodness no one was there. I thought to myself, “at least no one else was harmed.”
Once the car eventually came to a stop, and I gathered myself, I was able to climb out of the smashed driver’s side window. 30 seconds after somehow stumbling out of the car, the car burst into flames. “Whoa,” I thought to myself, “that was close.”
Sorry, I am getting ahead of myself here…let me rewind to the beginning. In late 2007, I had just moved back to St. Thomas, located in the US Virgin Islands (where I was born and raised). I had spent the previous year in Washington, DC, working for an Intellectual Property Law Firm, and I had my heart set on law school. That is until I realized I was spending the majority of my time researching businesses and investing my savings.
I was a regular person who worked, saved some money and tried to invest. So it was really by coincidence that I realized what I wanted to do the rest of my life. That is what brought me back to St. Thomas, the opportunity to work at an investment firm.
I had been working at an Investment Fund for a family office almost a year, and working very long hours to prove myself to the owners and my colleagues. Maybe I was trying to prove something to myself too. I would consistently wake up around 4:00 am to read and research, and would usually leave the office at 7:00 PM or later during the weekdays. The weekends were not much better. I was downright exhausted.
This brings us to the moment that changed my life FOREVER. That eventful car ride home on a Friday night would be a turning point in my life. Little did I know it at the time, but it would be a blessing in disguise.
It was an exciting time in my life. I had spent years trying to figure out investing. I thought I had an understanding, but the “Great Recession” caused almost everyone to second guess their approaches to investing (including my own).
Things were starting to recover, but people were so hurt by the preceding two years of market turmoil that market participants didn’t believe anything anymore. They thought the stock market was one big virtual casino now.
People were knowingly selling companies for much less than they were worth. There was certainly panic in the air, but as a value investor, I thought it was a great time to be buying if you had the moxie.
Thankfully I kept purchasing my best ideas. Things were starting to turn up for me, but at what cost? I was so exhausted and tired. The days seemed to blur together into one until it finally happened.
It was Friday night in September 2009. I’d spent about 80 hours at the office that week, and it was only Friday. I decided I needed a break, so I went out with a few of my good friends to a local pub. I left to head home a little after midnight. It was a typical St. Thomas night with the conditions dark and around 80 degrees. The windows were down, and I was listening to BB King (I know — probably not the best to listen to jazz music while driving home at night).
We drive on the left side of the road in the USVI. So I was traveling on the left side of the road on the north side of the island heading towards my house when the unthinkable happened:
I Fell Asleep At The Wheel…
The car had veered to the left of the road over the white line and hit a drain pipe. After the sudden crash, the drain pipe acted as a ramp and sent the car air born twisting sideways. The gut-wrenching noise from the accident woke me up to the car flipping and rolling over across the road and eventually sliding along the guard rail on the right side of the road, and finally coming to a screeching halt facing the other direction.
It was an odd feeling of weightlessness initially. Then came the ferocious body-rattling, thrashing, and violent careening that only a professional race car driver could know.
When the car finally came to a stop, I didn’t say a word. I knew I had to get out of the car — FAST. I was in a hurried state, but an eerie sense of calmness came over me as well. I assume the adrenaline was kicking in at this point.
The passenger side window frame was smashed in, and the driver’s side window was equally as bad. The entire left side of the car was also lodged up against the guard rail. I pulled myself through the small opening between the guard rail and the car window, cutting my arms and hands as I reached for freedom. Blood was starting to pour out at this point. I remember having glass in my hair for weeks from climbing through that window.
I know what you are thinking — WHAT DOES THIS HAVE TO DO WITH 80/20 INVESTING?!?!?
Don’t worry I will get to that shortly. I want you to know how this whole process started so that you can see all of the trials and tribulations it took to finally create a system. And hopefully, you won’t have to go through what I had to to finally create an 80/20 process.
There will certainly be times in your life, and in investing, when you think you’re down for the count. If you want to succeed in life and investing, it’s essential that we learn how to deal with these kinds of moments.
Personally, I’ve experienced a lot of tragedy in my life — I have had a best friend die in my arms from an asthma attack when I was 13 years old while studying for our final exams and lost my father suddenly when I was 23 years old leaving me as the head of the household. All of these experiences made me stronger as an individual, but it was incredibly painful at the time. I tell you this not to depress you or to ask for sympathy. Quite the opposite in fact. We can all learn from stressful situations and continue to evolve and grow. Each tragedy has changed my life for the better.
That’s how you have to treat “less than ideal” events or situations. Every setback is an opportunity. That’s life — when you fall or stumble, you have to learn how to pick yourself up, learn from the situation, and keep going forward.
I had no idea at those moments of extreme emotional pain that it would guide how I look at people and the world. Those moments gave me a high threshold for pain (physically and mentally), but it also made me understand the important things in life.
I am always of the belief that these things happened because I could take it. I have always sought out to accomplish difficult things. As they say, the bad times make the good times better.
The key learning point from these experiences in my life is that you must have that ability to FAIL FORWARD. The dark times are nothing more than an opportunity in disguise. It is just tough to see it at the time. That accident was a pivotal point in my life.
When I had time to reflect on what happened, I thought about how close I had come to dying. It made me think a lot about myself, my life, my future and what I wanted to be remembered for in life. I realized I had to incorporate certain habits and boundaries for myself in life, and I needed to create a process and a system that would help me invest more efficiently and effectively.
The reason that experience changed my life forever is that it made me realize that something had to change. I loved my job and investing too much to quit — it’s what I love to do.
However, it was killing me. I had to create a system that would help decrease the learning curve for investing and business research.
Little did I know that night, an economist would be the one to help change my life forever. It’s a shame he had passed away 100 years ago, I would’ve loved to have met him.
The man who changed my life is named Vilfredo Pareto. He popularized the 80/20 Principle or Pareto Principle.
I know…I know. Pareto’s Principle, or the 80/20 principle, has been paraded around the media as a way to “hack” your way through life or your career (or anything for that matter). And usually, I would cast off such things that have become popularized in the mainstream media. However, the disconnect occurs from people not using this simple principle (thus, we are safe for now as contrarians).
Important note: Although, Pareto was the first to popularize the concept, Tim Ferriss (Author of the Four Hour Work Week, et al.) was the one that led me to Pareto and his way of thinking. So he has just as much an impact on my life as Pareto, and for that, I am entirely grateful. Thanks Tim!
Pareto primarily established that “80% of the output from a given solution or system is determined by 20% of the input.” Here are some general examples of the 80/20 principle:
* 80% of the outcomes come from 20% of the efforts.
* 80% of ramifications come from 20% of the sources.
* 80% of a business’s profits come from 20% of the actions.
* 80% of investment success comes from 20% of the elements.
This list could go on forever. In fact, it would probably take an entire book to discuss how Pareto’s principle affects our lives on a daily basis. And the ratio is often even more disproportionate. It’s not uncommon to see 99/1, 95/5, and 90/10. Our focus will be on the 20% that gets us 80% of the way there. Once we get to the 80%, then you can hone in and focus more on the task at hand.
“What we fear doing most is usually what we most need to do.” - Timothy Ferriss
When I first came across his work, I was slaving over 12-15 hour days as a portfolio manager at an investment fund managing a Value Portfolio. It was no one’s fault but my own because I wanted to learn as much as possible, as quickly as possible. I had to know everything and all the businesses I was interested in at the time.
It took that near fatal car crash to realize that there needed to be a better way. Little did I know at the time that the near fatal crash would end up changing my life forever. Leading up to the accident, I was completely over my head and generally helpless (even worse, I had no idea at the time). I was waking up at 4 am to let my boxer dog (Harley) out for a walk, and I would start reading or researching something — anything I could get my hands on that I thought could help my career.
When I wasn’t coaching football as a volunteer head coach after work during the season, I was usually at work until 6 or 7 pm — and there was no end in sight.
The day after the crash (with the glass still in my hair), I opted to give Pareto’s 80/20 principle a chance. I thought to myself, “Why not…I did almost died right?”
In trying to ascertain how I was going to continue investing and managing money before it killed me, I scrounged up ONE question that would lead me down my journey to the unknown in investing:
Which 20% of elements are resulting in 80% of the results for investing success?
It’s certainly not an easy answer. Anyone would be skeptical of trying to respond to this question. But this wasn’t going to keep me from trying.
How did I do this, you ask…? Well, it wasn’t easy. I interviewed investors, studied countless more, and pulled out repeatable strategies and tactics they used (or didn’t use) to succeed.
I began to study my previous successful investments (and the bad ones as well), and I deconstructed and reversed engineered other investors’ top investments and failures. They have been used, refined and systematized into what you read today. All this research led to the formulation of the 5M™ Mental Model and MECOM™ Method, which are discussed in my book: Value Investing Edge.
However, this is the formula I used in search of a simple system: 80/20 Formula = Which 20% of (sources/elements) are resulting in 80% of the desired (outcomes/problems)? As you can imagine, the difficulty lies in establishing what 20% will lead to 80% of the results.
Although I have a natural affinity towards value investing, I also have an understanding of how dynamic and challenging it can be. I find value investing to be the most intriguing, fun, frustrating, depressing, lucrative, and exciting career you could ever have (I know that was all over the place).
And that’s the beauty of Pareto’s law. It helps you to “see the forest through the trees.” It helps you to focus on the most important elements first. Once those elements are executed or perfected, then you can venture outside of it.
“The art of being wise is the art of knowing what to overlook.” - William James
Being busy for the sake of being busy is a form of laziness. It’s lazy because it doesn’t take into consideration the elements that will produce results.
Focusing on the important few, while discarding everything else, is the way to a productive life. Of course, you will need to try many different ideas, strategies, and situations to ascertain what matters most. The process can be frustrating at first, but it’s a necessary process to see what “sticks to the wall.”
It could take a few days, a few weeks, or even a few months. However, once you’ve conducted this important process, you will know what works and what doesn’t. It’s just part of the process. So there’s no need to get frustrated by it.
Once you implement the 80/20 principle into your life, you will never go back. The 5M™ Mental Model is just one of many examples of the 80/20 principle in action that investors can use on their journey to investing success. Don’t let near disaster keep you from creating your 80/20 in life and investing.
What’s your story of 80/20 in Life or Investing?
ABOUT THE AUTHOR:
Lukas Neely is a former Hedge Fund Portfolio Manager and author of the Amazon #1 bestselling book (valuation), Value Investing Edge: A Value Investors Journey Through The Unknown. His work has been cited on such sites at Motley Fool, TED, Wall Street Journal, Bloomberg, ValueWalk, CBS, GuruFocus, Yahoo Finance, CNN Money, and Seeking Alpha. He is also the co-founder of Vantage Research, the provider high-quality investment idea generation, serving investment funds, portfolio managers, and sophisticated investors. Lukas is also the co-founder of BetterInvestingHabits.org.
If you’d like to learn more about Value Investing Edge: A Value Investor’s Journey Through The Unknown, grab the kindle version here, physical version here.
If after 10 minutes you don’t find at least 3 things you can do to make your life better I’ll refund your money.
That way you have nothing to lose… and everything to gain.