[The financial markets are closed today as America comes to grips with the devastation in New York City's financial district and at the Pentagon in Washington. Follow this link for more information and ways you can help those in need. The story below originally ran February 2, 2001.]
Stock picking. That's the focus on most nights of the week in this space. But my experience as an investor has led me to an ironic truth: Picking good stocks is one of the least difficult aspects of successful investing. In my personal portfolio, the problem has never been uncovering high-quality companies. Rather, the much more difficult side of investing tends to be exercising and maintaining control over my character. Qualities such as independent thinking, patience, and discipline -- these are the traits that I strive for. Foolish character traits such as these are what lead to market-beating returns over the long run.
Warren Buffett exemplifies the character of a Foolish investor. As the chairman and personification of his company Berkshire Hathaway (NYSE: BRK.A), Buffett has established a multi-decade track record of independent thinking, patience, and discipline. And since the Oracle of Omaha is famous for his Foolish sayings, I've included an apt Buffett quote to lead off each of the qualities discussed below.
I. Independent Thinking
"The most important quality for an investor is temperament, not intellect. You don't need tons of IQ in this business. You don't have to be able to play three-dimensional chess or duplicate bridge. You need a temperament that derives great pleasure neither from being with the crowd nor against the crowd. You know you're right, not because of the position of others but because your facts and your reasoning are right."
Question: Do you watch CNBC's Bob Pisani as he offers his daily rundown of the current "leadership groups," and think to yourself, "My portfolio needs a position in ______ (insert hot industry du jour)." Succumbing to Wall Street's "group think" is the surest way to earn mediocre returns. At best, you'll match the market by trying to keep pace with the latest flavor of the month. Then, when you factor in your commissions and tax costs, you're almost certain to underperform the S&P 500 Index. And that's to say nothing of the anxiety, headaches, and sleepless nights caused by constant portfolio churning.
My best investments to date have been the times I trusted my own analysis and hopped on board a ship that everyone else was bailing. Think Cisco (Nasdaq: CSCO) during the networking sell-off in spring 1997. Think Yahoo! (Nasdaq: YHOO) during the collapse of "Internet stocks" this past summer.
On the flip side, some of my dumbest opportunity losses have come from selling holdings because I didn't trust my analysis, and instead listened to the "experts" quoted in Wise financial publications. My most painful loss came when I sold Lucent (NYSE: LU) in early 1997. Of late, Lucent has hit the skids, but between 1997 and 1999, I missed out on a five-bagger because I read and believed some analyst's opinion that Lucent's markets were only growing approximately 10% per year.
Even in my naivete, I knew that Lucent made the things that made telecommunications work, and further, that our world was in the midst of a communications revolution. But somehow, I came to the conclusion that such a well-informed chap as this analyst surely knew more than I did. Pure, unadulterated Wisdom, it was, Fools. The market size for the telecom equipment makers is now estimated to be $1.5 trillion annually within only a few years, thereby fueling immense growth for the likes of Lucent and other network infrastructure providers who will supply the technology and know-how behind the networks of the future.
The obvious lesson is to do your own research, and then trust your own analysis.
"An investor should act as though he had a lifetime decision card with just 20 punches on it. With every investment decision his card is punched, and he has one fewer available for the rest of his life."
Folks, believe me, whatever I say about this one, I'm looking in the mirror as I say it. I'm not a patient person. Our microwave world has conditioned us to demand instant gratification. The buy-and-hold strategy requires immense patience as a stock goes through various periods of rapid run-up, interspersed with the inevitable stages of stagnation or decline. During the run-ups, it's always tempting to take profits. Conversely, during the downturns, it's easy to give up and sell. We've gotta fight those temptations. Patience with our holdings is critical in our pursuit of minimizing capital gains taxes and commissions. Over the long term, it's those frictional costs of trading that will make or break us in our quest to beat the market.
Once again, allow me to cite a few instances from my portfolio of what not to do. In the spring of 1999, two opportunities that caught my eye were SAP (NYSE: SAP), the global leader in enterprise software, and Intuit (Nasdaq: INTU), the leader in personal finance software such as Quicken and TurboTax. Both of these companies have some Rule Maker characteristics, including high margins and a dominant industry position. I bought 'em. Within six months, I ended up selling both -- at a loss. Why? Impatience, plain and simple. And look now, if I'd held on, I would've more than doubled my money in both at their current levels.
By the way, I found that one of the factors that exacerbated my impatience was use of margin. That's why I dumped margin -- never to return -- back in December (see A Marginal Opinion).
"I'm rational. Plenty of people have higher IQs and plenty of people work more hours, but I'm rational about things. You have to be able to control yourself; you can't let your emotions get in the way of your mind."
To exercise discipline is to rid ourselves of the lapses in patience and independent thinking that lead us to poor investment decisions. In other words, discipline requires self-control. Investing with discipline means only investing in a company after doing your own thorough due diligence. It means sticking to your planned monthly/quarterly savings and investment schedule. It means investing in a conservative manner, not speculating by "taking a flyer" or using margin irresponsibly. As with the other points above, if I have one finger pointed at you, I've got four pointed back at me. I need to work on this stuff as much as anyone.
Here's another personal example that exemplifies the antithesis of discipline. Early in my investing days, I was sitting around my dorm room watching CNBC. A news report popped up and mentioned that S3, a graphics chip board company, was hitting an all-time high of $19/share. With the cleverness of Wile E. Coyote, I thought to myself, "I bet I could scalp a few points off this one while it runs up." Whatever. The stock went down, and down, and down, and has never surpassed that day's highs -- ever. I bailed after a 40% loss. Ahh, the many lessons I've learned the hard way.
Warren Buffett is dead-on. So much of investing is not about IQ. Heck, anybody can match the market's return with an S&P 500 index fund. For many of us, that's the best route. It takes time, intellectual curiosity, and especially, I think, Foolish qualities to beat the market. Fool on.