Welcome to episode 27 of the Investing for Beginners podcast. In today’s show, we will be discussing six unconventional investing principles. These are ideas that Andrew has come up with that help you with some of the more difficult emotions related to investing.
These ideas are sometimes hard to implement, but when you are aware of them, it does make it easier to make a conscious effort to be more diligent about correcting our thinking.
- Let go of the results
- Don’t sign up for deals stacked against you
- Always build your power
- Don’t rely on one stock
- Don’t take pessimism too seriously
- Lose the ego
Andrew: Again I am going to talk about some principles today, and there is some good mindset stuff in here, and it’s not anything I’ve seen talked about in books or online. It’s just some stuff that came to me, trying to look from a mastery perspective and how some things and some experiences I’ve seen.
How can we kind of draw that in together and organize into useful tips?
For number one:
Let go of the results.
I think this is a mindset trap, where you see a lot of beginners particularly get into this. Everybody is, so results-focused and wanted to buy a stock and have it double it in a year. They want to get in on the next AMD, Amazon; they want just to have money and make that money grow very quickly and be able to realize those profits very quickly.
It makes people feel like they’re experts. Obviously, you become richer. It becomes such a focus where you’re deceiving yourself into thinking you’re becoming a better investor because you’re getting these short term results.
over the long term then could be unsustainable results, they could be negatively affecting you in the long term. Especially if you are getting into stocks that are very expensive and you may be at the tail end of a bubble curve for example.
So you could be getting some short term nice gains, only to see it crash right at the tip of a bear market, or market crash.
I think having this mindset where you let go of the results, focus on the things you can control. I like to do this too, and I talk about it in the eLetter all the time.
I’ll have months that are spectacular and see these performance numbers that makes my ego feel great, makes me feel like the portfolio is moving in a direction I want to see it go.
You have to take it with a grain of salt and understand if you are going to have a level head, you need to have a level head, especially in bear markets and turbulence. We’ve talked about all this before, and you can hear about time and time again, if you are going to have any success in the market, it’s going to come because of your holding for the long-term. You are riding out the ebbs and flows, ups and downs of the market.
You’re letting when the bear market comes you’re going to ride the recovery when the bull cruises along you are going to ride it up as well.
When you have a mindset where you don’t care too much about the results, you can be free to have this level head, to be stoic in both victory and defeat. If you have periods where you are underperforming, we have talked about Warren Buffett having periods where he was underperforming, Seth Klarmann has had them. I have had periods as well.
Understanding that those can be some short-term setbacks and you decide with your mindset how you want to perceive that and if you want to accept that and let it affect you emotionally or not.
It works on the flip side when you are doing great and just crushing it, and your stocks are really on the hot streak, all these stocks keep going up. The trick is to stay humble, stay stoic and understand just because there is a bunch of green in the portfolio today doesn’t’ mean that it is going to be the same way. It doesn’t mean that the current company will be in the same place five years from now.
Focus on instead on making the right decisions, not on where the stocks go because every single stock is going to move up and down. They are going to do what they do, and you are going to have sectors, individual stocks, the market will get hot.
The next day it could be cold, keep those things in mind and don’t put too much weight into it and you can focus your energy on the things that are important. Which are making prudent decisions for the long term, and you’re focusing on controlling the right things, like which stocks you’re going to buy and hold them.
Rather than the things that don’t matter like is stock A going to perform earnings estimates.
Letting go of the results, focusing on what’s important can help you go a long way as you try to select stocks.
Dave: I like the way you put that about the Stoic mindset, taking the emotion out of the investing part of it is so critical and crucial.
People get so emotional, and you see this on a day to day basis. Andrew was talking about the earnings report; there is a earnings season every quarter that the market goes through where people are looking very closely at how AMD did for the quarter, and they’ll base their decision on that short term three month period.
On whether they want to keep the stock or whether they want to sell out of it based on the short term view. It comes down to the emotional part of it as opposed to the fundamentals that Andrew and I preach.
I think that is so critical and crucial to having a sanity about what we are trying to do. There are so many emotions, and ups and downs in the market on a daily basis. If you watch company A for any period, you are going to see the stock price of that move in and out, up and down even in a day.
You could see it rise or fall a dollar just in that one day. You often wonder, I know I do as to why? What’s driving this? Is there some news happens that I am not aware of?
I have had this happen to me, even just recently where I was looking at a stock in particular that I bought and I hadn’t paid much attention to in a few days. I noticed that it had dropped a few percentage points and I thought to myself why what drove that?
I remember looking on their website, going to a couple of other stock news sites trying to find information about the company to see if there was something that I had missed. Maybe some bad news that had come out that I wasn’t aware of. There was nothing, it was based on a hedge fund deciding they didn’t want to be invested in that particular company, and it started a draw down on that company. Which started everyone bailing on the company, it was all based on emotion, nobody wanted to be caught holding the bag, even though there was no economic reason for the drawdown.
It was based solely on emotion, no hard, concrete facts. What Andrew was talking about is so appropriate, important to be a good value investor. Taking the emotion out of it, when you think about Charlie Munger and Warren Buffett they are very unemotional when it comes to this kind of stuff.
Charlie Munger is very involved in this newer field, last ten years or so, of behavioral finance. This arena has evolved in the last 5 to 10 years; there’s been a lot of work that has come out based on behavioral processes. This thought process is thought to have much more impact on our decisions than previously thought.
Charlie has a term that he calls Latticework of Mental Models, and I am not going to go into the whole details of it, because that would be a whole podcast, in and of itself.
The gist we make a lot of the decisions based on our emotions, and our emotions are based on models that we have of how to think about different aspects of our life, different aspects of decisions that we make.
It is a fascinating delve into the psychology of why we do what we do. It is a fascinating thing; I like what Andrew was talking about at this point.
Andrew: I like how you mention not only as an investor, do we need to be unemotional. But the emotions that surround the stock itself and the ones that you’ll see in the market and all the pessimism, optimism from the media.
And when you look at the basic analysis that companies and analysts are pumping out. It is going to be very emotional, and you need to control your own emotions but also not be fazed by the emotions of the market. I think that perfectly goes along with focusing on the right things and not getting too caught up in the results.
Number Two Unconventional Investing Principle
Don’t sign for up for deals structured against you.
I think this is something that you can see all the time, and not just in investing but throughout life. You can be spinning your wheels, trying to get something to work for you and you are in the wrong hamster wheel, expending all this energy and setting yourself up for failure.
As opposed to setting yourself up for success, and it is not your fault in the sense that it’s not because you’re trying too hard, or you’re not trying hard enough.
But because you are signing up for these deals that naturally work against. We’ve had examples of this in the past. If you go back into the past and look at our podcast where we talk about the things the financial industry doesn’t want you to talk about.
We talk about things like hedge funds, management fees and how those expensive and they are charging, for a service that can make your portfolio perform at a worse level than if you just let it stay. I think actively managed funds are a great example of a deal that is structured against you.
Another one would be shorting. You try to short a stock and what you’re doing is your flipping everything. Instead of going long on the stock. When you flip that you are betting short, you are betting that the stock price is going to go down. You are pessimistic on the company, and what you are also doing, which can be lost by these Investors and traders.
Bless their hearts, they just jump right in, without any worries about the technicals and fundamentals. YOu get caught up in the game, and you just lose the picture by doing this, if you think about buying a stock. Say I want to pay a $100 and I want to invest in Apple.
Worse case experience is that I buy a whole bunch of 100 shares of Apple and they go bankrupt; then I lose my $10. Best case scenario is the sky is the limit. The stock market is constantly changing, and it is to see these companies do well again at least for a short time.
There always seems to be a new company that has a new market cap, and you always hear of the S&P hitting new records. We have this thing that is the stock market, and it represents the business world, and it’s limitless in how much it can expand and grow to create profit and capital.
There is no way to predict how high a stock can go; the possibilities are limitless. If you flip that around and short a stock instead of buying it. The most you can gain on the short is 100%. If you want to capitalize on the stock falling further, you would have to open another a short position and compound it in that.
When you’re betting against the stock, because the stock could price could increase infinitely, now you’re instead of your upside being infinite, your downside is infinite. If you’re a beginner, you might not know how shorting works. But the basic premise is that you have to put down collateral because in the case that the stock shoots up the broker needs to be able to cover that difference.
You have to put collateral down and have a leverage account so that they can draw money away from, in the case, the stock shoots up and debits the money, and you owe them the money. You can have a thing called a margin call where if the stock shoots up by a certain amount and you’re in the hole a bunch of money you have to come up with that collateral upfront, just to keep the position open.
If you don’t they are going to see you don’t have enough capital to continue the trade, and it closes out, and you can’t stay in the short position any longer.
As you can see, even though it’s a 50/50 game in the sense that a stock could go up and down on any given day, but by trying to always guess the winners instead of the losers you’re now entering into a game plan as a way to put it. This is structured to help you, the risk reward paradigm. And number two, the longer you are in that trade, the more you lose. Because the longer I am in a regular long position, every three months I am collecting a dividend payment.
When you are in a short position now you are paying out those dividends payments, so that is just another factor.
These types of trades are designed against you, and putting you in the most beneficial, and looking for an advantage by understanding these bigger picture kind of situations that you can go in and out of.
It can help your performance in a really big way. Because half of the battle is just at the right spot at the right time.
If you’re jumping into deals that are structured against you or the probabilities are that you will lose more, in the long run, we are talking ten years or decades if you’re looking for that long of a period. Sure, you can probably do better. Over a long time, you want the stocks favored in your section.
Certain structures like mutual funds, hedge funds, you are trying to utilize them for they are structure to make other people rich. Try to stay away from those things.
Dave: Yeah, if you want a really good illustration of how the shorting thing works, watch the movie the “Big Short.” It sets up exactly how this whole process works, and there are several lines where they talk about vividly and in detail how short works and how much money it costs.
In Michael Bury’s case, it was millions of dollars he was spending every month to short the housing market.
Andrew: It almost bankrupted him, and he was right too.
Dave: It’s such a gamble, he was a brilliant man, and it was such a risk and a huge gamble for him. He was proven right, but he very well could have been wrong and like Andrew could have gone bankrupt.
To me, that is the best illustration of what Andrew was talking about.
Another great illustration would be short that Bill Ackman has on Herbalife, that’s been going on for years and can’t even imagine how much that has cost him.
What Andrew was saying is so accurate, and it is a great principle to keep in mind when you are investing.
Andrew: You know what’s funny about Ackman is he could be right in five years and still lose money on the trade. Just because of the way it is structured.
The next one I will try to be more concise.
Number Three: Always Build Your Power.
I think if you want to pick stocks for yourself and try to beat the market by buying stocks that are undervalued, getting in low buy situations. You always have to be feeding yourself with knowledge, getting ideas, and trying to have foundations, and having your mindset evolve and grow, become better.
The ways that we recommend people do this, obviously read books. If you listen to this podcast, I think that is a fantastic way to build your power day by day.
There are other resources; some people like investing newsletters, some of the blogs, there’s a ton of ways you could go. I think that it is really important, I am not saying you need to be plugged in every day or anything like that.
Over time if you want to give yourself the best chance at keeping a level head, having confidence, and being able to get the best results over the very long term. I think you need to be building your skillset as you go along.
Working out, I don’t know what but everybody loves to use the working out analogy when it comes to talking about money. It is because there are a lot of parallels. When you workout, in the beginning, you get quick gains, is what they call it. You get linear growth and explodes without having to put in extra work.
The difference between somebody who is in the middle and somebody who is an expert, there is still a big difference there. Because the expert is putting in the time and time. My point with that is that we’ve talked before and I like to mention this on my blog a lot. Even an advantage of 1% outperformance, it sounds minuscule, and when you add compounding interest and you get that one percent, adding that one percent the next year and another.
It just grows over time, go to google.com right now if you don’t believe me. Find a compounding interest calculator and then exponentially explodes with each one percent outperformance you get. This is one of those things where you could find the mastery in that extra oomph is going to reward you in really great ways.
Don’t expect that you can find that extra outperformance if you’re not building you knowledge, and skill set every single day. Over time and staying on top of it and trying to essentially become better, just trying to get better over the long-term, trying to mature while your portfolio matures as well.
Dave: I think the easiest way for me to think about that is “Knowledge is Power.” The more you know, the better you can do. Like Andrew was saying I think the analogy of the weight lifting although I must be doing something seriously wrong because I don’t see any linear growth, that is probably a whole another conversation.
The more you know, the better that you can do, you just think about anything you do in your life, whether it is exercising, reading, at work, the more that you know, the better you can do your job.
I think about when I first started working in the banking world. I knew nothing about it, and it was so overwhelming to work there at first. As my knowledge grew, so did my comfort in my job and my abilities with my job.
Think about when you first bought your first stock, how terrified you were and what a scary experience it was. Now, because of your increased knowledge and experience, it is not so scary anymore.
Just remembering that knowledge is power, you don’t have to do it every single day, but if you’re a geek like me and like to do it every single day, then more power to you.
If it is not as interesting to you, but you still want to do it, then find a blog you want to read, listen to the podcast, reading is key. As you read, the more you learn, the better you’re going to do it.
I keep coming back to it; Knowledge is Power.
Andrew: All you have to do is look at guys like Warren Buffett, he is still a learning machine. At a much great scale, personally I am, and I am sure most people. He is just a voracious reader.
Principle Number Four:
Don’t rely on one stock
Obviously, you hear the whole diversification thing being always talked about throughout finance. They talk about not wanting to put all your eggs in one basket, but if think about not the loss side, but also the winning side.
You also don’t want to rely on all your gains coming from one stock. When I talk about the gains, I am trying to think to form a very long-term perspective. Because everybody’s goals are different, but I know for me when I hit that financial freedom point or spot where I can start to live off the dividend income that I am receiving from my portfolio.
That ideal portfolio will have several positions that have grown over time, they have been paying dividends all along, those dividends are growing, and I am collecting shares. You see an income; it’s almost like having a job.
If you have five fantastic stocks that are providing substantial dividend income, you can reasonably feel safe in not working and relying on those checks to come in.
It happens all the time in the business world where a company can just run into big troubles and have to cut the dividend, if you have a reliance on multiple stocks, instead of just one. Your dividend checks are essentially safe because you are not relying on any single one to keep you going.
You don’t have to sell any stocks, draw out of your portfolio, you can just let time do its thing. Continue to reinvest or spend those dividends. A much stronger portfolio is one with a bunch of really strong dividend payers rather than just one or two nice positions that are feeding you income.
Dave: I agree, you think about some of the people that we talk a lot about, and that we look up to and admire. They all have anywhere to 6 to 20 positions or more, and they do for that reason. They do that for a reason because they found other good ideas that will generate income for them.
It also helps hedge against the bad choice or a company for whatever reason, goes south. Thinking about Monish Pabrai, one of the guys that I like to read his work, and his writing. He is extremely intelligent guy and a great writer.
He’s one of those people that is so smart that he makes everything look easy, it’s not easy. He can explain complicated topics and make them sound easy. He talks a lot about his positions, he doesn’t’ have a lot. I think the last time I looked at his portfolio he had six or seven positions, which is not a lot.
But he did have a company recently that went belly-up, it ended declaring bankruptcy. For a while, it was making him some serious returns. But management made some very bad choices; they ended up going bankrupt. But because he had other positions and he didn’t have his whole life savings sunk into that one particular company.
It hurt him, but it didn’t hurt him that bad. That to me was a great real life illustration of why you don’t’ put all your eggs in one basket.
I know there is a gentleman in Brazil, can’t remember his name at the moment. He owned a company, and he was at one point one of the richest men in the world. But his company went bankrupt, and he lost everything because his wealth was tied up in that one company.
That’s the peril of getting into one position, and that’s where all your money is you’re going to come from.
Andrew: The next principle, really trying to take a contrarian approach.
Don’t take pessimism too seriously.
What I am talking about is not taking the pessimism that can surround the stock. If you want to b a value investor, who is bargain shopping. Somebody who can figure out what the intrinsic value of a company. Number two, find stocks that are trading at a discount to that intrinsic value, picking those up and either getting the profits from that value difference or holding on seeing those profits grow over time.
You want to be that kind of investor; you are going to have to go against the crowd. You’re going to have to face pessimism, and honestly, you’re going to have to laugh in its face and understand that it’s ridiculous. Even though that the crowd may be saying that you’re the idiot, understanding that it’s the pessimism and the numbers and the logic behind what’s going is over the long term at the end of the day is going to be justified more so than what the short term emotions are.
It goes back to the stoic thing but you really to have to be able to tackle pessimism head on. I remember company like BP when it had the oil spill, the stock plummeted and the earnings took a hit for a while. There were value investors who went in there and swept up some shares and did well.
I don’t know how the stock has done. Lately, there are examples like that all the time where stocks get beat up, and they get the scarlet letter on CNBC and in the media.
There are other investors that are understanding that ok, yeah there might be a short-term little hiccup here, we have a strong business model here, long-term cash flow. In general, it doesn’t seem to be in an industry that is shrinking; those are the type of opportunities that you are going to want to jump on.
We’ve talked about Corning before, that is a great example of a stock that was looked down upon because it had gone sideways for so many years. But sure enough at that low price, it was at such a low price, and it was trading, depending on how you want to make the intrinsic value calculation, either you could say it was trading near that, below that, or above that.
There is just no way over the very long-term it was going to trade in that range for very long unless the company went belly-up. Sure enough, it didn’t go belly, the company was strong after all, and the stock price soared up afterward.
These kind of examples are things you see in the market all the time. It is not something you will see covered in the media all the time because it is not flashy, spectacular like three times growth, same store sales growing by double, or triple. There is no hot new innovative product or service or anything like that.
There are these companies all the time that are reliable and having some adversity and showing an opportunity because they are trading at lower than what they’re worth. If you can come in as a value investor. Analyze the situation rationally and see that there’s value in that position.
Not only buying the pessimism but holding through the pessimism, even holding through some additional adversity that might come up in the next three to six months, two years, however long it might be. You can see some nice profits, not only in the short, medium or long-term. I think that it is a strategy that you can continue to repeat it and over decades of time, you’ll find it wins more than it loses.
Dave: Yeah, you are right on about that. I think that the illustration that you gave about Corning was a great one, one that came into my mind while I was listening to you was Wells Fargo.
Just recently the company went through a bit of scandal, and there was a lot of negativity about the company. And I know that Andrew is not a big fan of investing in banks but I am and it’s because I work for banks and am more comfortable with the inner workings of what goes on in a bank.
The company got beat up pretty bad, and the price dropped to the mid $30s, and I was able to buy some, and now it’s back up in the high $50s. It has gone up quite a bit, and that was an opportunity where people were so negative and pessimistic about the company. But when you looked at the underlying factors that were involved in the company as far as their return on assets, return on equity, some of the other metrics when I am investigating a bank were all great.
Just because there was a lot of pessimism and negativity in the news about the company the underlying financials of the company hadn’t changed. It was to me a good investment, and I was able to make a good return on it. That to me is what is looking like going against the grain and being a contrarian because if you looked at everything else that people were talking about it was all doom and gloom.
Andrew: Love how you have a very recent example of that working for you.
Last principle and we’ll wrap up here.
Just drop the ego.
It’s pretty simple, something that can trip up beginning investors is that you start to get analysis paralysis, either it’s too much information, or you have this perfectionism, and you don’t want ot make a mistake.
You want to have everything lined up before you jump in, and I get that. I’ve been there, and I am that kind of analytical type of person and can completely relate. Understand if you’re listening there is a 99.9% chance that you’re not Warren Buffett, and if you call me.
Nobodies are watching, and nobody cares what stocks you are buying unless you have followers are watching what you are doing. If you are average investors and going along buying stocks and trying to learn as much as you can, trying to get some dividends, compounding interest your way.
No one is going to see you make a mistake and there is no way you can go through life not making mistakes, that you talk about the whole metaphor with the bubble wrap and the kids these days.
It’s harmful to think and have a mindset where you’re not going to make a mistake and to try to avoid mistakes at all costs. The only thing that this perfectionism is going to do for you is to prevent you from taking action.
If you are having trouble with that, I think the number one thing with that is to drop the ego. It is ok if you make a mistake, nobody is judging and is so focused on them. I think you will find that taking these “risks” and putting your money out there and buying stocks on your conviction.
It is going to be way more beneficial to you than if you’re just going to self-criticize, criticize others, or put yourself into the self-defeating loop where you think that there just no possible way to win.
Seriously just do that and have the confidence, faith to leap of faith. You will do fine, this is not something that you will learn overnight. If you are going to follow these principles, build your power, do these types of things over time. You are going to do fine and chances are you are going to do better than fine.
Stay humble, remember all of the principles, don’t be too emotional, don’t get swept up with everything that is going on, and don’t take away all your power. Do all those things, and I think you will have nice results at the end of the day.
Dave: I agree, and I think the ego thing is so important. I think about the people that I look up to and admire. They don’t have an ego about what they are doing. You don’t hear Warren Buffett out there standing on a mountain top proclaiming how great an investor he is.
He is a teacher, and he loves to help people, loves to teach people how he does what he does. Charlie Munger is the same way, so is Monish Pabrai. I think they come from a place of abundance; they don’t come from a place of power and ego.
They don’t brag about how good they do, it just a function of what they do and how they do what they do. Andrew and I don’t talk about how we do on our percentages because it doesn’t matter, it’s not important.
Andrew and I are more making good decisions and be rational about our choices of investments. It’s not about bragging and talking about “I’ve got a 75% return on this company”, well good for you. It’s not about comparing yourselves to other people.
It’s a matter of us figuring out a way to be successful with the tools that we have available. I come back to this all the time. The margin of safety that Andrew and I talk about all the time, and the emphasis that we place on the safety that’s because we are trying to take the ego out of what we are doing.
If you have an ego, you don’t need a margin of safety because you will never make a mistake, and I’m here to tell you; you are going to make a mistake. The trick is to learn from your mistakes and try not to make the same mistake twice.
That is going to do it for us tonight. Thank you for taking the time to listen, and I hope you enjoyed our discussion about the 6 unconventional investing principles.
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Have a great week, and we will see you next week.