3 Principles of Successful Investors

“There are some people who, if they don’t already know, you can’t tell ’em.” – Yogi Berra

Are you one of those investors for whom things just seem to always work out well? Getting superior long term returns seems to take little effort. Whatever strategy you use seems to eventually work. You don’t spend much time or effort, yet most of the time you are feeling quite confident about your investments.

Or are you the type of investor who always seems to struggle? It seems everything you buy goes down right after you buy. When you finally sell, they take off. And the investments you hold long term mostly underperform.

We have often encountered both these types of investors. Struggling investors are far more common. They usually have trouble believing that many investors outperform with little effort. Those that find investing effortless just shake their heads at the frantic activity of struggling investors. This applies to both professional and amateur investors.

Why is it that investing is so easy for some and for others it is always a struggle?

We have found that the biggest reason for this difference is an underlying belief system of successful investors. This belief system tends to result in effective behaviour. The success of the investor tends to result more from their behaviour than from the specific investments they own.

From our years of experience, we can usually get a good idea of how successful an investor is just from talking with them and identifying their belief system, even if we know nothing about their investments.

There are 3 main principles that tend to make up the belief system of successful investors:

1. Faith

The single most important characteristic of successful investors is faith. This includes faith in the markets, in the future, in our free enterprise system, in the ability of good companies to grow their profits, and in humanity.

Successful investors tend to have this confidence and optimism. They see how much humanity has progressed in recent history and tend to see their optimism as realism. They don’t know how things will turn out all right – they just know that they will turn out all right.

This faith tends to give them a long term focus. They don’t need to keep searching for some great investment, do all kinds of transactions or get into the latest fads, because they are confident that their investments and the markets will perform well over time. Whenever their investments are down, this same confidence allows them to just see it as an opportunity to buy more. They tend to get good advice or choose their investments carefully, but then hold them a long time.

How can they outperform so easily? All you need to do to outperform is to own high quality investments for the long term and generally buy more whenever they are down. That’s all! The markets produce a good return over time and so should your investments if they are high quality. At least twice each decade, there will be a significant down market, which is your opportunity to invest more at lower prices. This alone means your return will be higher than the investment itself.

This is usually done with high quality mutual funds, broad index funds, or a well-chosen, diversified portfolio of stocks. We do it with “All-Star Fund Managers” that have all beaten their indexes long term and that we believe are the world’s smartest investors available to us.

Whichever specific investments they have, successful investors tend to have a calm confidence in their investments. The reason this is so important is that one of the single most important factors in investing is to stay invested and keep investing at market lows.

Many investors will make decent returns during a bull market, but then make the #1 mistake in investing by selling after the market tanks and losing years of growth. By selling, they miss the inevitable recovery. This #1 investing mistake is a direct result of not having faith.

Confident investors know that market declines happen, but since the markets have historically risen about 70% of years, declines are never probable. They are never focused on avoiding the next 20% down tick; but rather on being invested during the next 100% up tick.

Meanwhile, struggling investors tend to have a general anxiety about investing, a fear of losing money and a general pessimism resulting from their lack of faith.

They are constantly searching for the right investment, the right time to buy and sell, and use charts to try to market time effectively. They tend to believe that recent trends will continue and tend to “follow their gut”. Most of their information is free information from the news, internet, or other investors. They are always concerned about the “apocalypse du jour” (next crash, Peak Oil, deflation, inflation, etc.), anxious about missing opportunities, scared of losing money, and usually have a grossly exaggerated view of how risky the markets are. They are often “performance maniacs”.

Their lack of faith leads them to many behaviours that tend to reduce investment returns, such as frequent trading, market timing, performance chasing, trend following, lack of diversification, and most significantly, getting caught up in bubbles or selling after a crash.

The key point is that because successful investors have faith in the markets and their investments long term, they focus on participating effectively in the long term market growth. Struggling investors, with all their activity, end up trying to outguess random stock movements.

2. Patience

The most successful investor, Warren Buffett, often says: “The stock market is a highly efficient mechanism for the transfer of wealth from the impatient to the patient.”

Successful investors tend to focus on having high quality investments and/or advice, and tend to stick with them long term. Part of their belief system is that they don’t know when it’s going to turn out all right – they just know that it’s going to turn out all right.

Struggling investors tend to change their strategy/investments/advice often based on their outlook. For this reason, we consider them to have “STD” – selection and timing disease – the delusion that anxiously searching for the best investment/sector/strategy and timing it right is the key to successful investing.

Studies, such as the Dalbar study, consistently show that the average investor makes only about 1/3 of the return of the investments they own. In other words, 60-67% of lifetime returns are lost by performance chasing, speculative euphoria at peaks, panic capitulation at market bottoms, market timing, buying investments because of recent returns and other similar investing mistakes. These mistakes result from “short term-ism” (short term viewpoint) and cost on average 600 basis points per year (6%/year).

Struggling investors, or as we call them: “investors with STD”, often focus on the cost of investments (fees and taxes), but don’t see the huge cost of their investment disease.

A great example of the problem with “short term-ism” was the markets early in 2009. Did that look like a screaming buying opportunity to you at the time? For patient investors, that was as obvious as King Kong smashing buildings in New York. In our opinion, it was definitely one of the most obvious buying opportunities of the last 70 years and likely the most obvious one during our lifetime. We did publish an article on MDJ in March about “Irrational Pessimism”.

Yet many people that somehow think they are able to time markets (obviously they can’t) missed the early 2009 screaming buying opportunity. By simply having faith, being patient and investing more whenever the market declines, you could not possibly have missed such an obvious buying opportunity.

This was the largest market decline in the last 70 years, which is why it was the best buying opportunity of the last 70 years. Period. If you just have faith and patience that the markets go up long term, you would have had no hesitation in buying more while it is low.

In contrast, investors with STD focus on short term, random market movements, news, chart formations and market timing. They were trying to predict where the market would move next (which is never obvious), so they probably missed the best buying opportunity of our lifetime.

When you compare any 2 investment strategies, you will find that nearly always, the one that results in fewer transactions is the superior strategy. We have been surprised at how often we have noticed this effect over the years.

Fewer transactions are more effective.

This is why, for example, studies consistently show that women are significantly better investors than men.

If studies are ever done, we believe they will show that investors in broad market indexes generally do well, but investors in ETFs will do poorly over time. The ETFs themselves will do fine, but because they are made for market timing and have an average hold of only 12 days, the investors in ETFs will do poorly, in our opinion.

A rather humorous example of this phenomenon happens in families where one person (usually the guy) handles all the investments for both spouses. The portfolio of the spouse (usually the wife) tends to have a higher return than the investing spouse’s portfolio. This happens because he tends to trade more actively with his own portfolio. This tendency applies to investment advisors as well, where their spouse’s account usually has a higher return than their own.

Just like amateur golf, successful investing is more about avoiding mistakes than about making that great shot. As one advisor put it, “My wife and I have almost always had the same investments, except that I’ve done more stupid things in my account.”

The key point is that successful investors are patient with their investments, choose them well and have a long term view.

3. Discipline

Discipline is the decision to keep doing the right things. It is the decision not to do something wrong.

Struggling, STD investors tend to ask: “What’s working now?”, while successful investors care about what’s always worked over time.

Discipline is part of why it is so important to have a long term financial plan and why we don’t take on clients without a financial plan. Successful investors are goal oriented, and therefore planning driven. Struggling, STD investors are market-oriented, and therefore performance driven.

When you know your “number” – the nest egg you will need to have the retirement you want – you tend to be focused on long term financial freedom. This makes you far less likely to be thrown off course by a bear market or market bubble, or the myriad of financial events that happen in the world or in your life. Fundamentally changing the portfolio when your goals have not changed is virtually always wrong, and will depress returns.

If struggling, STD investors have an advisor, they tend to think their advisor’s main job is advice on the selection and timing of investments. Successful investors, however, usually realize that the #1 job of their advisor is not investment A vs. investment B, but to modify the natural tendency of the investor to behave inappropriately.

Behavioural Finance books list many irrational behaviours that result from the logical shortcomings of the human mind. Successful investing requires the discipline to prevent these mistakes.

In short, the behaviour and the belief system of the investor are the key factors in superior lifetime investment returns. Struggling investors are usually afflicted with “Selection and timing disease” (STD), while successful investors tend to have faith, patience and discipline.

* This article is based on our personal observations over the years and the writings of Nick Murray, a retired advisor that I consider to be a mentor. Much of our investment philosophy is based on his principles.