There is a common view among amateur and professional investors that the key to investing profitably lies in contrarianism -- that is, to focus on zigging when everyone else is zagging. But the problem with this belief is that it can get an investor into as much trouble as if he or she were instead to slavishly follow the crowd.
Contrarianism isn't an end in itself
If you study the great stock operators in American history, it's clear that none of them viewed contrarianism as an end in itself. They viewed it rather as a byproduct of a much more important objective: intellectual independence.
The difference between contrarianism and independence may seem insignificant, but as the old saying goes, the devil is in the details. Let's assume, for instance, that you were an investor at the time Henry Ford started mass-producing automobiles. While the contrarian response would have been to double down on companies that manufactured horse buggies, it seems obvious, at least in hindsight, that such a move would have been a costly mistake.
And the same can be said about any number of industries that are in the process of being disrupted today. Take specialty bricks-and-mortar retailers like Best Buy and Barnes & Noble as examples. The preponderance of evidence implies that these companies can't compete against the likes of Amazon.com, Costco, and Wal-Mart. Yet there remains a sub-current of thought that investing in them amounts to a smart strategy because, at least in part, doing so goes against the crowd.
Given this, it should come as no surprise that an investor as successful and acclaimed as Philip Fisher, one of Warren Buffett's two intellectual mentors, strongly advises people against blind contrarianism in Common Stocks and Uncommon Profits:
Much has been written in the literature of investments on the importance of contrary opinion. Contrary opinion, however, is not enough. I have seen investment people so imbued with the need to go contrary to the general trend of thought that they completely overlook the corollary of all this which is: when you do go contrary to the general trend of investment thinking, you must be very, very sure that you are right.
In other words, if you've independently developed an opinion about a particular stock that happens to be contrary to the general sentiment in the market, then there's a value to being contrarian in that specific instance. But if you haven't, then there isn't.
How to achieve independence in thought
When you look at investing through this lens, two things become apparent. The first is the importance of isolating your investment decisions from the influence of those around you. It's no coincidence, for instance, that Warren Buffett set up shop in Omaha. "It's very easy to think clearly here," Buffett said in a 2012 interview with the Associated Press. "You're undisturbed by irrelevant factors and the noise generally of business investments."
And it's also no coincidence that many of the greatest investors of the past, such as Jesse Livermore and Bernard Baruch, shared an equal appreciation for "playing a lone hand" by ignoring unsolicited tips and inside information. Both scions made this point in their writings, but never more clearly than Baruch does in the first volume of his memoirs -- which, by the way, is well worth reading if you get the chance to do so:
The longer I operated in Wall Street the more distrustful I became of tips and inside information of every kind. Given time, I believe that inside information can break the Bank of England or the United States Treasury.
It is not simply that inside information often is manufactured to mislead the gullible. Even when insiders know what their companies are doing, they are likely to make serious blunders just because they are in the know.
There is something about inside information which seems to paralyze a man's reasoning powers. For one thing, people place a great store on knowing something other people do not know, even if it is not true. A man with no special pipelines of information will study the economic facts of a situation and will act coldly on that basis. Give the same man inside information and he feels himself so much smarter than other people that he will disregard the most evident facts. I have seen insiders hold on to their stocks when it was obvious to nearly everyone else that they should be sold.
Over the long run, I have found it better to rely on one's own cold detached judgment of the economic facts.
The second thing that becomes apparent is the importance of isolating oneself from the financial media. Indeed, one of the most unfortunate but underappreciated realities of investing is that business-related news is not designed to educate or inform. Instead, depending on who you talk to, its true purpose is either to benignly entertain you or, more nefariously, to induce you to do things that you shouldn't, such as actively trading stocks or investing in a company that, in one way or another, has garnered the media's favor.
This is a point that Henry Clews, the "Sage of Wall Street" in the decades following the Civil War, made in his autobiography Fifty Years in Wall Street:
The object of [financial news] agencies is a useful one; but the public have a right to expect that when they subscribe for information upon which immense transactions may be undertaken, the utmost caution, scrutiny, and fidelity should be exercised in the procurement and publication of the news.
And yet it cannot be denied that much of the so-called news that reaches the public through these instrumentalities must come under this condemnation.
How far these lapses are due to the haste inseparable from the compilation of news of such a character, how far to a lack of proper sifting and caution, and how far to less culpable reasons, I do not pretend to decide; but this will be admitted by every observer, that the circulation of pseudo news is the frequent cause of incalculable losses.
I emphasized the last sentence because it expresses a point that can't be repeated enough. "People don't watch ESPN and then think they're supposed to go out and play tackle football with 300-pound guys," says Josh Brown, an on-air contributor to CNBC's The Halftime Report. "But for some reason, when they watch financial or business news, they then take the next step in a lot of cases and say 'I'm supposed to act on this now.'"
Valuing independence over contrarianism
Buffett is undoubtedly right when he says that one of the principal keys to investing profitably is "to be fearful when others are greedy and greedy when others are fearful." But this classic cliche of contrarianism papers over the more fundamental goal of thinking independently. In short, there is a time and a place for going against the crowd, but the only thing that will get you there is a thought process that allows you to draw your own conclusions.
John Maxfield has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and Costco Wholesale and owns shares of Amazon.com, Barnes & Noble, and Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.