I've spent an enormous amount of time studying successful money managers, from those still active today, including Berkshire Hathaway's
My goal has been to learn from all of their successes -- and, equally importantly, their failures. Given that investment mistakes are inevitable, I'd at least like mine to be original ones.
So what have I learned? I've discovered that long-term investment success is a function of two things: the right approach and the right person.
The right approach
I believe strongly -- and there is ample evidence to back me up -- that the odds of long-term investment success are greatly enhanced with an approach that embodies most or all of the following characteristics:
- Think about investing as the purchasing of companies, rather than the trading of stocks.
- Ignore the market, other than to take advantage of its occasional mistakes. As Graham wrote in his classic book The Intelligent Investor, "Basically, price fluctuations have only one significant meaning for the true investor. They provide him an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times, he will do better if he forgets about the stock market."
- Buy a stock only when it is on sale. Graham's most famous saying is: "To distill the secret of sound investment into three words, we venture the motto MARGIN OF SAFETY."
- Focus first on avoiding losses, and only then think about potential gains. "We look for businesses that in general aren't going to be susceptible to very much change," Buffett said at Berkshire Hathaway's 1999 annual meeting. "It means we miss a lot of very big winners, but it also means we have very few big losers. ... We're perfectly willing to trade away a big payoff for a certain payoff."
- Invest only when the odds are highly favorable -- and then invest heavily. As Fisher argued in Common Stocks and Uncommon Profits, "Investors have been so oversold on diversification that fear of having too many eggs in one basket has caused them to put far too little into companies they thoroughly know and far too much in others about which they know nothing at all."
- Do not focus on predicting macroeconomic factors. "I spend about 15 minutes a year on economic analysis," said former Magellan
(FUND:FMAGX)manager Peter Lynch. "The way you lose money in the stock market is to start off with an economic picture. I also spend 15 minutes a year on where the stock market is going."
- Be flexible! It makes little sense to limit investments to a particular industry or type of stock (large-cap growth, mid-cap value, etc.). Notes Legg Mason's
(NYSE:LM)Bill Miller, "We employ no rigid industry, sector, or position limits." Miller's Value Trust (FUND:LMVTX)is the only fund to beat the S&P 500 index in each of the past 15 years.
- Shun consensus decision-making, since investment committees are generally a route to mediocrity. One of my all-time favorite Buffett quotes is this: "My idea of a group decision is looking in a mirror."
The right person
The right approach is necessary, but it's not enough for long-term investment success. You also need the right person. My observation reveals that the majority of successful investors have the following characteristics:
- They are businesspeople, so they understand how industries work and companies compete. As Buffett said, "I am a better investor because I am a businessman, and a better businessman because I am an investor."
- While this may sound elitist, they have a lot of intellectual horsepower. John Templeton, for example, graduated first in his class at Yale and was a Rhodes Scholar. I don't disagree with Buffett -- who noted that "investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ" -- but I would point out that he didn't use the numbers 160 and 100.
- They are good with numbers -- though advanced math is irrelevant -- and are able to seize on the most important nuggets of information in a sea of data.
- They are simultaneously confident and humble. Almost all money managers have the former in abundance, while few are blessed with the latter. "Although humility is a trait I much admire," Charlie Munger once said, "I don't think I quite got my full share." There are many other areas of investing in which humility is critical, which I discussed in "The Perils of Investor Overconfidence."
- They are independent and neither take comfort in standing with the crowd nor derive pride from standing alone. Bargains are rarely found among the crowd. Neff said he typically bought stocks that are "misunderstood and woebegone."
- They are patient. Templeton noted that "if you find shares that are low in price, they don't suddenly go up. Our average holding period is five years."
- They make decisions based on analysis, not emotion. Miller wrote in his Q4 '98 letter to investors: "Most of the activity that makes active portfolio management active is wasted ... [and is] often triggered by ineffective psychological responses such as overweighting recent data, anchoring on irrelevant criteria, and a whole host of other less-than-optimal decision procedures currently being investigated by cognitive psychologists."
- They love what they do. Buffett has said at various times: "I'm the luckiest guy in the world in terms of what I do for a living," "I wouldn't trade my job for any job," and "I feel like tap dancing all the time."
Much of what I've written may seem obvious, but I argue that the vast majority of money in this country is managed by people who neither have the right approach nor the right personal characteristics. Consider that the average mutual fund has an 86% annual turnover, 132 holdings, and no investment larger than 5% of the fund.
Those statistics are disgraceful! Do you think someone flipping a portfolio nearly 100% every year is investing in companies or trading in stocks? And does having 132 holdings indicate patience and discipline in buying stocks only when they are on sale and odds are highly favorable? Of course not. It smacks of closet indexing, attempting to predict the herd's next move (but more often mindlessly following it), and ridiculous overconfidence -- in short, rampant speculation rather than prudent and sensible investing.
Foolish bottom line
The characteristics I've described here are not only useful in evaluating professional money managers. They can also be invaluable in helping you decide whether to pick stocks for yourself. Do you have the right approach and characteristics?
This article was originally published in July 2001. It has been updated.
Fool analyst Joey Khattab, who updated this article, does not have a position in any of the companies mentioned. The Motley Fool has a disclosure policy.