He describes his approach as “Heads I win, Tails I don’t lose much”, which ties in with his idea of “Low risk, High uncertainty” investing which he picked up from entrepreneurs. Entrepreneurs generally do not gravitate towards a high-risk, high-return scenario but do everything they can to minimize risk; they focus on low-risk bets which have high-return possibilities.
Here are four behavioral techniques he suggests that you use to be a better investor:
1. Be Singularly Focused
There is a valuable lesson from the story in the Mahabharata. Dronacharya is going to test the princes on their archery skills.
To do that, he puts a fish on a pole and inserts the pole in a pool of water. He points it out to the students and tells them to shoot out the center of the eye of the fish.
One by one, as the princes step forward, he asks them what they see. They each give different answers, I see the pole, I see the fish on the pole, I see the water, I see the fish… As they answer, he tells them to step back. Finally, Arjuna is asked that question. He responds: I see the center of the eye of the fish. Dronacharya permits him to fire at will and he takes the eye out.
That is how you must approach investing.
I really don’t care what the Reserve Bank or Federal Reserve does with rates. Or what is happening on the geopolitical and macro scene. None of that is relevant to what I am trying to get done.
I am focused on identifying businesses that are within my circle of competence, figuring out what they are worth, and then seeing if they are available ideally in this environment for one-fourth or less than what they are worth.
2. Don’t Short
Shorting never ever made much sense to me. I mean, your maximum upside is double if the company goes to zero, and your maximum downside is bankruptcy. I don’t know why anyone would want to kind of play with those thwarts.
If I go long when I buy a stock, I don’t have to put up more capital when it goes down. When you short a stock and it goes up, you have to keep putting up capital, and such capital calls have no limit. That’s a very unpleasant place to be. I have never shorted a stock in my life. I think I will go to my grave without ever doing so. And I think it’s a very simple exercise.
Buffet and Munger say that they have identified hundreds of great short candidates. They’ve been right almost 100% of the time and they’ve been wrong on the timing almost 100% of the time.
So, the problem with shorting is that you can’t get the timing right. And markets don’t follow any kind of rationality. They can price things at 1x earnings and such. They can do all kinds of strange things to a stock crisis. I would steer clear of activities that require me to look at quotes every five minutes.
3. Be Wary of Debt
Shakespeare had a character in Hamlet call Polonius. When Polonius’s son is embarking on a long journey, he shares some advice with him. One of them is, “neither a lender nor a borrower is.”
Buffet rephrased Polonius when he said, neither a short-term borrower nor a long-term lender is. And if you look at the testosterone-fueled NBFCs, they forgot to read Hamlet. And they forgot to read Buffet.
They basically loved the fact that if you borrowed short and lend long, you get really fat juicy spreads. But the problem with borrowing short, which we saw in the financial crisis, is you got to turn that paper over. Most leveraged financial institutions go bust without running out of money. They usually go bust because they run out of confidence way before they run out of money.
Look at the NBFC crisis in India. The assets of the entities were good, I think the assets were solid, but they’ve got liquidity mismatch and there was no reason to have a liquidity mismatch. If you are lending to someone for 5 years, borrow for 5 years as well. And yes, if you borrow for 3 months or 1 year, you will get a bigger spread. But, to finish first, you have to first finish. And you don’t get to finish the game if you do that.
4. There Are Times You Will Be Wrong
Accept that you will be wrong at least one-third of the time. John Templeton is the one who cautioned us about it.
In my 45-year career as an investment counselor, that career helped me become humble because statistics showed that when I advised a client to buy one stock to replace another, about one-third of the time the client would have done better to ignore my advice.
If we are going to try to figure out the future of a business, what a business looks like 5 or 10 years from now, by definition, that type of an endeavor is going to have a very high error rate. Simply because there are lots of uncertainties that come in when we look at long-term futures of businesses.
Now, when we are wrong, it doesn’t mean that we lose money. It could be that you thought, oh, the stock is going to triple and it flatlines or maybe it goes down 10% or maybe it goes up 50%, but it doesn’t do what you expected it to do. And the good news with the investment business is that even with a very healthy error rate, even if you are wrong 4 out of 10 times, you are going to hit the ball out of the park.
So, if you are a brain surgeon, you cannot have a 40% error rate or a 4% error rate or even a 0.4% error rate. It doesn’t work. But the investing business is a very forgiving business and it tolerates a high error rate which is great.
Cover Image Source: Guru Focus