Are average returns enough to achieve your goals?
Following rock star fund managers and trying to emulate their success is likely to end badly for most investors. It’s better to shoot for above average or even average results to achieve your investment goals.
Open a business newspaper or magazine on any given day and you’re bound to find an article or snippet on a rock star investment manager – Warren Buffett, Ray Dalio, Howard Marks, or locally, Phil King, Geoff Wilson and others. It’s natural and understandable for investors to look to replicate the strategies and successes of these managers.
What the same newspapers and magazines rarely include are the fund managers who aren’t doing well or have failed. The failures far outweigh the successes, yet you’ll almost never hear about them. For instance, the managers who’ve trailed indices for some time or those who are forced to close funds.
Triumph being made more visible than failure isn’t just an investing phenomenon. It’s everywhere.
Think about musicians. We’re overloaded with news about Taylor Swift. How she’s a billionaire, how she’s sold out her music tours, and how she’s broken up with another boyfriend. We don’t hear about the tens of thousands of wannabe musicians who don’t make it professionally, even though many are extremely talented.
The same goes for sport. Roger Federer still makes headlines even when he is retired, but we don’t read about the hard luck stories from the thousands of tennis players who couldn’t quite get to Federer’s level.
The same goes for books. The chances of getting on a New York Times bestseller list are tiny. Around 3 million books are published each year, and just over 6,000 of them end up on these lists, or 0.00208%. Becoming a famous author is a rarity.
There’s a behavioural psychology term for all this: survivorship bias. We focus on the successes rather than failures, and consequently overestimate our ability to be a success in a certain field.
You’re not Warren Buffett
Consider Warren Buffett. You might have heard of him. Buffett is a financial genius and was a genius from a young age. Recently, I read a speech from a hedge fund manager which gave a fantastic insight into the extent of Buffett’s genius. Mark Sellers gave the talk – So You Want to Be The Next Warren Buffett? How’s Your Writing - to a group of Harvard MBAs in 2007.
Sellers was blunt:
“I know that everyone in this room is exceedingly intelligent and you’ve all worked hard to get where you are. You are the brightest of the bright. And yet, there is one thing you should remember if you remember nothing else from my talk: You have almost no chance of being a great investor. You have a really, really low probability, like 2% or less.”
Sellers went on to say that the Harvard students before him were undoubtedly a cut above the rest, and that meant the chances of the average person becoming a great investor – which he defined as one being able to compound returns at 20% per annum – were much smaller still.
Sellers thought that by the time that your brain had developed in your teenage years, you either had the ability to be a great investor or you didn’t:
“… you can’t compound money at 20% forever unless you have that hard-wired into your brain from the age of 10 or 11 or 12. I’m not sure if it’s nature or nurture, but by the time you’re a teenager, if you don’t already have it, you can’t get it. By the time your brain is developed, you either have the ability to run circles around other investors or you don’t.
Going to Harvard won’t change that and reading every book ever written on investing won’t either. Neither will years of experience. All of these things are necessary if you want to become a great investor, but in and of themselves aren’t enough because all of them can be duplicated by competitors.”
Sellers then listed seven key traits of extremely successful investors:
- The ability to buy stocks while others are panicking and sell stocks while others are euphoric.
- They are obsessive about playing the game and wanting to win.
- A willingness to learn from past mistakes.
- An inherent sense of risk based on common sense.
- Great investors have confidence in their own convictions and stick with them, even when facing criticism.
- It’s important to have both sides of your brain working, not just the left side (the side that’s good at math and organization).
- The ability to live through volatility without changing your investment thought process.
Sellers thought none of these traits could be learned by the time that you reach adulthood.
Number 2. on Sellers’ list is worth elaborating on. If there’s one thing that stands out from Alice Schroeders’ biography of Buffett, The Snowball, it’s not only his precocious ability from a young age, but his willingness to sacrifice everything to get wealthy. And I mean: everything. He was addicted to investing and neglected his wife, children, and friends, to achieve his goals.
Not only is Buffett’s genius rare, but his investing obsession is rarer still.
Better to shoot for average, or better than average
Sellers in his speech wasn’t all doom and gloom. He said that though the Harvard students were highly unlikely to become great investors, they could become above average ones through hard work and study. And that beating indices by a few points each year would hold them in good stead.
Shooting for above average results, or even average, is sage advice. It reminds me of US fund manager, John Neff, who ran the Windsor Fund from 1964 to 1995. In his biography, he comes across as a low key and humble man, and his portfolio often reflected that. He liked to buy stocks at a 40-50% discount to the market price-to-earnings ratio, with steady, growing earnings, and sound balance sheets. In other words, there were no momentum stocks, or loss-making ones on price-to-sales ratios of 10x or more. He stuck to low priced, steady compounders.
He ground away at that simple strategy for 31 years, beating the S&P 500 by 3.1% per year. It doesn’t sound like much, but it resulted in $10,000 (with dividends reinvested) turning into $564,000 over the life of the fund.
Neff was more concerned with avoiding large losses than making big gains. In that, he echoes the sentiments of the great investment consultant, Charles Ellis, whose book, Winning the Loser’s Game, I’ve written of previously.
Ellis writes of how the stock market has become a loser’s game. That is, so many professional investors have entered investing that it’s made the market extremely efficient. It makes beating the market difficult and even more so if you include costs such as fees and brokerage.
Ellis says there are two ways to play a loser’s game. You can choose not to play. Even back in 1975, Ellis was already advocating index investing.
The second way of playing the loser’s game is by losing less than your opponents, aka making fewer mistakes:
“In a Winner’s Game, 90 per cent of all research effort should be spent on making purchase decisions; in a Loser’s Game, most researchers should spend most of their time making sell decisions. Almost all of the really big trouble that you’re going to experience in the next year is in your portfolio right now; if you could reduce some of these really big problems, you might come out the winner in the Loser’s Game.”
