After my post last week, titled “How will you measure your life?… and improve it.”, I got thinking and asked myself: why is it that there is so much which we read about and actually already know but can’t seem to apply properly? This question is applicable and valid for several aspects in life, but let’s stick to investing for now. As pointed out by several famous investors, investing is not rocket science (although some people make it look like it is) and therefore understanding its different concepts shouldn’t be an obstacle to applying the process of investing and be successful at it. So, if understanding the theory isn’t a problem, what makes it so challenging then? Well, we are human beings and a large part of the answer lies in the fact that human nature is far from perfect and, as investors, we have to fight against it. This was in part highlighted in Chapter 8 of The Intelligent Investor by Benjamin Graham which was recognized as one of the most important chapters by Buffett. That’s all fine, but I’m not quite satisfied with that answer. If that’s the answer to our initial question then what can we do about it? Several investors have been able to counteract natural tendencies of human nature and become very successful, so there has to be a way (or many ways).
Between knowing something and applying it successfully, there’s the process of internalization – and this is key! Because of human nature, internalizing a concept can be extremely difficult. So, let me give you my thoughts on how to internalize as an investor and try to speed up the process as much as possible. Internalizing something would usually come with experience and this is why experience and grey hair, especially in investing, is so valuable. However, there are ways to become better, faster.
1- Take action
Seth Klarman: Investors Can No Longer Rely On Mean Reversion
"For most of the last century," Seth Klarman noted in his second-quarter letter to Baupost's investors, "a reasonable approach to assessing a company's future prospects was to expect mean reversion." He went on to explain that fluctuations in business performance were largely cyclical, and investors could profit from this buying low and selling high. Also Read More
“Just do it” says Nike and they’re right. Simply reading and studying won’t make it, you have to take action. (See one of my first posts “Don’t sit on the sideline”) Don’t wait for the perfect investment. First, it doesn’t exist. Second, you won’t be able to find good investments if you don’t practice. Another crucial aspect of taking action is to set clear objectives for yourself. The ultimate outcome of investing is easily measurable as it revolves around money. Let me use a very simple example to illustrate this concept. As you know, compounding is one of the pillars of long-term investing and if you are serious about investing, you’ll want to use this concept to your advantage at a personal level. The first step (or objective) should be to accumulate a certain capital base, which you will NOT spend (against human nature) and which you will grow and compound over time. Let’s say your objective is to accumulate $100,000 by the time you are 30 years old and compound it for the next 50 years at a rate of say 15%, without adding to this amount over the 50-year period. If you are able to do this and resist the temptation of spending any of it, you’ll end up with over $108 million by the time you turn 80! Obviously, you won’t be able to generate a stable 15% annually as it will fluctuate over 50 years, however you can easily track your results against where you should be say after 5 years, 10 years, etc. and see if you’re behind or ahead of your objective. For professional investment funds, it can be a bit more challenging as you depend on third-party investors (investments and redemptions). However, quality funds would normally have a long-term approach and the senior partners will be able to provide at least a minimum capital base (skin in the game). And needless to say that for professional investment funds, tracking returns is of the highest priority.
2- Help support your logic
Most people have the brain power necessary to invest successfully (not many use it properly though). So, how can you improve faster and do better than others? And most importantly avoid human misjudgments. The answer is fairly simple, but hugely important. Don’t rely only on your brain, your past experience and what you’ve been able to retain over the years. You need to establish a system – just as we did with the Investment Decision System (IDS) series a few weeks back. Building your system will allow you to record what you already know but also reflect thoroughly on what you’re writing down. We’re always a lot more careful about our thoughts when we put them in writing. Once your system is established, it’s not the end (but rather the beginning). You have to improve and build on it… remember the snowball effect? That means improving your checklists, keeping a database of your mistakes, keeping notes of new important concepts read, etc. All this information should be recorded and consolidated in a simple way which you’ll be able to retrieve and refer to easily. The ultimate goal is to take the best decisions possible. Be a learning machine!
3- Help support your memory
Most of us have a terrible memory. At least, I know I do. In addition, our memories are often influenced and distorted by subsequent events which can severely impact our rationality. So, don’t assume you know just because you’ve done it dozens of times in the past. The example of pilots is quite a relevant one in this case. Experienced pilots certainly know how to take-off, especially after years and years of experience. However, before each take-off, they still go through their checklist to make sure they haven’t forgotten anything. In their case, going through that checklist can be the difference between a normal flight and a disaster. Therefore, before taking a decision, make sure you go through every step of your written-down process. Repetition will make the process as fluid as possible and help internalize all that you’ve accumulated over time.
In short, in order to internalize and avoid misjudgment: take action, follow up on your achievements vs. your objectives, establish a well thought of process updated on a regular basis, and refer to your system every time. Repeat. One last thing: be brutal about it. If you start deviating from your good practices, you’re doomed. Internalization asks for extreme consistency.
Featured image: Internalization requires repetition… Source: frumgirlmusings.wordpress.com