This classic Bill Mann investing article was originally published Jan. 11, 2002. Some information has been updated.
Many moons ago, so long ago that we cannot even confirm whether it is true, the Dead Letter Office of the U.S. Postal Service received a letter with a completely bizarre address. Now, the Dead Letter Office is generally the last stop for mail that can neither be successfully delivered to the recipient nor returned to sender, due to a lack of address, illegibility, or bad information. The people who work there will take a last crack at discovering just who is supposed to receive the letter, and where that person might be.
This particular letter was addressed as follows:
WOOD
JOHN
MASS
And wouldn't you know it, the fine folks at the Dead Letter Office figured it out and delivered the letter to its intended recipient. We don't know whether the sender considered his test a success or not. What we do know is that the sender used an addressing strategy that entailed a high level of risk of complete failure: that is, that the letter would neither be delivered nor returned.
Fortunately, in letter writing, there is an agreed-upon protocol that eliminates a great deal of the risk involved in getting a letter to its intended recipient. Follow the protocol of writing the correct name, a street address, city, state, ZIP code, and country (if needed), affix proper postage, and the likelihood of the letter being delivered is really high. You can deviate a bit and chances are still quite good. Leaving off the ZIP code, for example, is rarely fatal, nor is misspelling the name of the addressee. Only someone who actually wishes to "test" the post office would intentionally deviate too far from this protocol. Letter addressing is, thus, a science.
Invest
ing
ain't letter writing
Investing, alas, is not. It is very much an art, and there is no rule that has ever been written in investing that does not create exceptions. For this reason it is often quite unnerving to write articles that we hope have general application, because as sure as I am typing this now, nearly everything we write has exceptions that are built in. For example: Don't invest in penny stocks. Great advice, timeless advice. But wouldn't you know it, Home Depot (NYSE:HD), currently a $75 billion company, was once listed on the pink sheets. So was Sun Microsystems (NASDAQ:SUNW), and so was Benjamin Moore Paints when Berkshire Hathaway (NYSE:BRK-A) bought it a few years ago. There is no investing advice that has ever been uttered that always works. Well, except maybe this gem from Will Rogers: "Buy some good stock and hold it 'til it goes up and then sell it. If it don't go up, don't buy it."
Nor do any two investors have exactly the same goals. In an article published in 2000, I discussed John Bogle's concept of the four components of investing: risk, reward, time, and cost. Of these four, the only one that is completely outside of the control of the investor is reward. Generally speaking, you can control your risk by insisting in investing in companies that contain certain characteristics, you have control over the amount of time you will be in the market by being mindful of your goals (sending a kid to college, retirement, etc.), and you have control of the cost at which you buy a company. Reward you don't control, and I am sure that there are people who had managed parts one, two, and three quite well and still ended up in AT&T (NYSE:T) or Halliburton (NYSE:HAL) as they spiraled to earth in 2001. Halliburton has recovered to beat the market since then; AT&T has not. I'm sure investors in neither appreciated the ride very much.
But this is about as libertine as I can be about investing, because over the long term, there are certain strategies that work better for larger numbers of people than others. It's kind of like the address above -- there is a clear risk that does not outweigh the likely benefits. Once again, this is going to make some people mad, because I will by necessity be treading on toes where some feel they have done quite well using some particular strategy. Bully for you. But we have to deal with what gives investors the best chance to generate wealth over the long term. We danced this particular dance in the past when some who have done very well trading options thought I was providing a disservice to people by saying that, on the balance, there is no inherent superiority in portfolio strategies -- including options.
But just as options trading should be avoided by most folks, so too should most folks avoid cornering themselves in the following:
1. Get-rich-quick schemes. Whatever they are, however they are packaged, get-rich-quick schemes generally offer the investor nothing more than a really convenient way to lose some money. There was a story about a kid who was fined $900,000 by the Securities and Exchange Commission for defrauding "investors" who thought they were "investing" in a guaranteed sports betting program that would return up to 25 times their money. I cannot, for the life of me, figure out how someone could be so stupid as to fall for this, and yet that 900 large came from somewhere. Chasing instant riches in the stock market offers only a marginally better chance of success.
2. Obsess ing a bout stocks. I saw a term once (I wish I remember where) that a guy used as his own philosophy for investing. He called it "wholesome neglect." He called this form of neglect the single best characteristic among the most successful investors he knew. I'd suggest that most of the best investors have a sort of humility about themselves -- they are aware of the fact that they cannot outsmart the market. Warren Buffett describes his own activities as "bordering on sloth," though he does do an enormous amount of reading and research in between his occasional buys and sells. Wholesome neglect means that you treat your portfolio as a vehicle to accumulate wealth. This means not worrying about the "hot" sectors, this means not worrying about getting the exact top or bottom, this means letting your winners run, but selling your losers. Wholesome neglect is far different than "buy and forget," because there are very few companies that are really of a quality that would warrant them being bought and locked away.
3. Avoid ing l osses at all costs. Even the best investors own some losers. The best basketball players miss some shots (nearly half of them), the best chess players lose games, the best writers have churned out some clunkers. Ever read Shakespeare's Titus Andronicus? Ewww. Even when your research is thorough, things may not work out as planned. Count on it. So although we like getting companies cheaply, we are not afraid of paying a little bit more for a higher-quality company. Make sure that you get value for your money, but do not feel afraid to buy a company at a slight premium if it is clearly superior to other companies in its sector. Quality does not come cheap, and sometimes, cheap ends up being expensive. Tiffany & Co. (NYSE:TIF), for example, is unlikely to ever be cheap relative to its peers. But even in the horrible economic environment of 2001, Tiffany's holiday sales were only down by 2% from the prior year. Why? Because the robin's-egg-blue box speaks volumes, and that branding provides the company with a natural advantage over its competition. We may get our timing wrong on Tiffany, but I sincerely doubt that shareholders have overestimated its quality.
Proper investing means spending time to learn about how you look at the information before you and the company's prospects. It is not easy, and it is certainly not obvious. Just like the address at the start of this article, which, after several detours, showed up at its intended destination: John Underwood, Andover, Mass.
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Bill Mann co-pilots the Motley Fool Hidden Gems small-cap investing newsletter. At time of original publication, Bill owned shares of Berkshire Hathaway and Tiffany. Home Depot and Berkshire Hathaway are Inside Value picks. The Motley Fool isinvestors writing for investors.
