The One Simple Thing That Will Instantly Make You A Better Investor

Everybody wants to be a successful investor. To do so, we must find advantages that provide the proverbial “leg up” on other participants making individual investment decisions. The literature points to four advantages investors have historically leveraged to gain an edge or advantage. These include informational, timing, analytical, and behavioral.

This article outlines why all but one of these advantages are invalid and should not be pursued. The only legitimate advantage, and the one that instantly makes you a better investor, is the behavioral advantage. Before I dig deeper into why maintaining a behavioral advantage is critical to investment success, I will go ahead and debunk all the other aforementioned “advantages.”

The informational advantage asserts that an investor has access to information others are cannot access. 50 years ago, this probably would have been a huge advantage. Nowadays, everybody has access to the same information. Inaccessible information now takes form as “insider information”; according to the SEC, insider trading is a big no-no. The analytical advantage asserts that an investor can analyze a stock better than most people out there, and therefore have an analytical advantage. With the sheer amount of Ivy-league grads working 60-hour weeks at large investment institutions, it is safe to say your analysis isn’t superior. I freely admit my analysis is no better than any analyst on Wall Street. People who believe they have this advantage tend to fall prey to the self-attribution bias (will detail in a future post). The timing advantage, in my opinion, has never been an advantage…ever. If you think you can time the markets — correctly pick the highs and lows — you’ll get taken to the cleaners. Nobody can predict the future. Magical crystal balls aren’t a thing. Think about it…if the collective investor sentiment determines stock price, then how could one possibly ascertain the outcome of millions of people making millions of individual market decisions? Answer: it’s impossible.

Bottom line: These advantages do not exist.

I’m not alone in my assertions. Warren Buffett, Seth Klarman, Joel Greenblatt, and Jack Bogle, some of the world’s greatest investors, agree with me. So, with that said, what exactly is this “behavioral advantage” that has given investors an edge for so many years?

An investor secures a behavioral advantage when he or she combats negative influences, avoids emotional investing, and remains objective and stoic in the face of uncertainty. Rational investors don’t let short-term price movements produce adverse emotions (and the resulting bad decisions). Think about it…people that buy and sell on the open exchanges are human beings. People are emotional, often irrational creatures. The rational, levelheaded investors are the ones able to exploit the emotional investing of untrained investors. In my opinion, having that mindset is the second most important factor in determining investment success. Some of the negative influences we must combat are greed/envy (making irrational decisions to compete with or mimic the decisions of another investor), fear (decision paralysis), suspension of disbelief (people mistakenly believe “new economic norms” will prevail), ego (chasing unrealistic returns to boost your ego and prove “alpha”), and capitulation (holding on to beliefs for a long time, then finally giving into the herd mentality. Howard Marks, one of the greatest value investors of our era, perfectly explains these influences in his book titled The Most Important Thing.

“The desire for more, the fear of missing out, the tendency to compare against others, the influence of the crowd and the dream of the sure thing — these factors are near universal. They have a profound collective impact on most investors and markets. This is especially true at market extremes. The result is mistakes — frequent, widespread, recurring, expensive mistakes.”

Don’t be exploited. Be the exploiter.

If you can fight off these negative influences, you will not buy and selling at inopportune times and can act on other’s emotionally unstable investing practices. You can confidently sell when prices are elevated and confidently buy when prices are low.

That, my friends, is the advantage we can leverage to be better investors…instantly.

However, like most things in life, deliberate action is much easier said than done. How does one remain levelheaded and logical? Some examples below:

1. Confidence in your analysis — If you are confident that your investment is worthy and has upside, you will not be so quick to sell. Having an understanding of the industry helps you gain a greater understanding of the company your are buying, and it’s role in that particular industry. I believe it goes without saying that an investor should understand the company in which they are buying stock.

2. Don’t check stock quotes daily — Checking stock prices on a daily basis inspires action. When one of your picks goes up, you feel elated and believe you are smart for picking that stock. When that same stock goes down, you might think, “maybe it’s time to sell”. This logic is flawed — short-term price movements rarely reflect the viability of the company’s long-term outlook. Check stock prices on a weekly or monthly basis.

3. Diversify — Building a diverse portfolio is an excellent way to fend off negative influences. When properly diversified, there is no need to fret, as that one stock or asset is not a large enough part of your portfolio to worry. Discussing different diversification methods is a whole other blog post in itself, so I’ll to keep it short. You can diversify through mixing asset classes, industries, or regions around the world (emerging markets vs mature economies).

4. Be completely objective in your selection AND selling process — some people have biases to certain stocks. Example: “I love Twitter! I’ve been an avid supporter since day 1! I will never sell the stock!”. This is unsound practice — in the investing world and most other endeavors in business alike. Objectivity is something Warren Buffett preaches time and time again.

5. Invest in ETF’s and index funds — these types of investment will mimic market returns. These instruments own a tiny piece of a whole index. For nonprofessional investors, I highly recommend these types of investments. They are not volatile, and in a vast majority of cases, outperform money managers and financial advisors.

6. Focusing on the long term — I’m sure many of you have heard this phrase ad nauseam…however, I cannot say it enough. If your time horizon is five years, why worry about a 5% drop in stock price? Has anything fundamentally changed about the stock, the market, or the industry? If not, then don’t sweat the small stuff. Note: This only applies if you TRULY understand the company or asset (or you invest in ETF’s and index funds.

7. Building a portfolio from a position of strength — If you invest $10,000 in the markets, but cannot withstand minor capital depreciation, then you fall into the trap of being a “trader,” and unknowingly adopt the propensity to make irrational decisions based on short-term, mostly meaningless price movements. If you are playing the markets to get rich as opposed to building wealth, you are almost certainly bound to lose.

As mentioned above, proper demeanor is the second most important determinant of success or failure in the financial markets. Do yourself a favor and check our Vanguard’s study on how “discipline” drastically alters the outcome of your investment strategy:

Check out the interactive graphs to compare the returns of disciplined investors vs. emotional/irrational investors. It’s mind blowing!

Don’t be exploited. Be the exploiter.

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