Beating the market

I got an email about a small cap stock service that I will ignore, but they used a Buffett quote I had heard before, which I think ties into this board’s investment strategy vs just indexing. The quote is as follows:

“If I was running $1 million today, or $10 million for that matter, I’d be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.”

Since indexing tends to beat the majority of mutual fund performance, the best advice for most people is to just invest in indexes and be done with it. I recommend this personally to most people because I know that investing is hard and most people have biases that cause them to lose money. A lot of people are risk averse and should not be buying individual stocks. Many people would panic when a stock like Square falls 20% in one day. During the UBNT Citron short attacks, I remember posters being scared out of their shares even though Left’s claims were baseless. These are normal reactions for most people; heck even many seasoned investors sometimes have these reactions. This is the reason that indexing is a great way to go for most people. Even Saul said the same in this exchange:

What would you recommend to someone who wants to invest, but not spend much time on it?

Saul: Invest in index funds, or ETF’s that track the market. Investing in individual stocks requires that you enjoy doing it. And that you enjoy doing it enough to spend some time at it.

See link here (this is great read by the way): https://chrisreining.com/saul-rosenthal/

However, I think the Buffett quote rings true and is largely demonstrated through Saul’s performance and by those on this Board that are handily beating the market. I know Saul is not achieving 50% average returns, but to me the quote relates to being able to beat the market by a large margin. I do not think 50% is achievable in the long term for those managing a small portfolio, but I think achieving 20-30% on average is possible for those who follow’s Saul’s methodology and are willing to take on more risk. This means volatility and not panicking when the market has a sell off. It also means not falling in love with stocks and being able to cut ties when performance starts deteriorating (this is a skill I need to improve). It means having a more concentrated portfolio so you can really follow your investments. It means staying fully invested and not trying to time market corrections. It means taking advantage of sell-offs that are not driven by a change in company performance. It means being aware of your biases and trying to discount their impact on your investments (price anchoring is a big one). We have a big advantage over big mutual funds in that most of us do not manage that much money and we don’t need to answer to investors on a short term basis. We can be nimble and not impact the stocks we are buying or selling.

With Saul’s (and others) YTD performance closing in on a 100% gain for 2017, I think we have even more evidence that using Saul’s methodology, you can beat the market on average.

So thanks Saul for making us all better investors and teaching us “how to fish”.

47 Likes

Give a person a fish, and feed him for a day.

Teach a person to fish and feed him for a lifetime.

1 Like

Wouter,

Good write-up.

My .02…

  • A mistake I made quite often when I was younger was generalizing from a small amount of data.
    It may be true that you can beat the index, but one year’s result – a sample of one – is more
    likely to mislead you than help you in your decision making. Even ten years or more. I know that’s
    not intuitive but it’s very easy to be fooled by random events. If you haven’t already explored
    Daniel Kahneman’s work, you may find it helpful.

http://www.econlib.org/library/Enc/bios/Kahneman.html

  • Although volatility is an issue, there’s a more critical risk when you invest in an
    individual business, especially these early stage companies. It’s the risk of permanent loss of
    capital. Some of these firms fail in sudden and unexpected ways. You lose everything you’ve
    invested in them. I’ve done that. What I learned from that is not to waste time trying to figure
    the odds of each one of them failing but to work out a strategy to deal with that risk.

Thanks,
Ears

9 Likes

Give a person a fish, and feed him for a day.

Teach a person to fish and feed him for a lifetime.

Teach a person risk arbitrage and you can bankrupt his whole village.

5 Likes

Wouter,
I agree with almost everything you said, but I would posit that volatility and risk are two very separate things. I would caution against conflating the two.

3 Likes

“If I was running $1 million today, or $10 million for that matter, I’d be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.”

Hi Wouter, Thanks for that excellent quote from Buffett, and thanks for the kind words for me. I said something almost exactly the same in the Knowledgebase. A larger portfolio does slow you down:

Please note: It’s a lot harder to make great returns as the amount you are managing gets larger. You can’t just get in and out of a stock with one or two trades as the dollar amounts become too big. You can’t invest in companies that are really small or illiquid, because it’s too difficult to accumulate a position that will be meaningful to your portfolio. And if there’s bad news you’ll be stuck and unable to get out in a hurry without moving the market. It’s like turning a battleship instead of turning a motorboat. Now that my own portfolio size has grown to the size it is, averaging 30% to 35% growth per year just isn’t going to happen. I can no longer put all my money in a half dozen little stocks, or get in and out of a stock position on a dime as I could when my portfolio was a tiny fraction of the size it is now. I just can’t be as nimble as I was and I’ll be very happy now if I can average 22% growth per year instead of 32%.”

4 Likes

Wouter,

This means volatility and not panicking when the market has a sell off. It also means not falling in love with stocks and being able to cut ties when performance starts deteriorating (this is a skill I need to improve). It means having a more concentrated portfolio so you can really follow your investments. It means staying fully invested and not trying to time market corrections. It means taking advantage of sell-offs that are not driven by a change in company performance. It means being aware of your biases and trying to discount their impact on your investments (price anchoring is a big one).

You have distilled Saul’s approach into a nice short paragraph. Very nice!

Chris

13 Likes

…volatility and risk are two very separate things.

Agreed, they aren’t synonyms.

But there is risk associated with volatility. That’s one reason people conflate the two.

For example, your stock takes a dive and a competitor with deep pockets scoops up the business
for pennies on the dollar. You’ve just experienced a permanent capital loss.


Incidentally, if you’re a student of Mr. Buffett you probably can appreciate the irony of the
quote Wouter picked in the context of this board. Mr. Buffett said those words at the height of
the bubble in the summer of 1999 when he was being ridiculed for not buying high-flying technology
stocks – many of them early stage companies with no earnings – and instead buying “dull” stocks
like General Re and MidAmerican Energy with low growth but predictable earnings and return on
investment. He’s a very competitive guy, so it’s not surprising he responded to his critics that
way.

However, Buffett’s rule number one is don’t lose money. Rule number two is don’t forget rule number
one. His priority is managing risk, not chasing returns.

Here’s one of his ground rules from the partnership years…

“I cannot promise results to partners. What I can and do promise is that our investments will be
chosen on the basis of value, not popularity; that we will attempt to bring risk of permanent
capital loss…to an absolute minimum by obtaining a wide margin of safety in each commitment and a
diversity of commitments, and my wife, children and I will have virtually our entire net worth
invested in the partnership.”

Ears

12 Likes