Saturday, July 27, 2013

10 Investing Lessons Learned

Ten years ago this week, I started my first job in the investment industry and it seemed a fairly decent occasion to reflect upon some of the key principles I've learned thus far in my career. 

  1. Patience is paramount. Having worked with a number of ultra-high net worth individuals, I learned that the common theme in their portfolios was patience. Not a single one was on the phone with us multiple times a day placing trades. Sure, the clients had questions about their holdings now and then, but they stuck to the agreed-upon strategies and were letting time do the work. In some cases, they still held onto shares of companies that their grandparents had bought half a century earlier and were simply letting the dividends roll in year after year.

  2. Always consider incentives. Investors typically spend the majority of their research time investigating the company's income statement, balance sheet, and cash flow statement. While the information on these statements is obviously important, I've found that far less time is spent researching executive incentives and pay packages, which can be found in the annual proxy statement (14A) in the U.S. (In some markets, this information can be found in the annual report.) Unlike the historical financial statements tell you what's already happened, reviewing management's incentives can help you understand how management will steer the company going forward.

  3. You need to have a good information filter. With so much financial information available today, it's essential to know what's important and what isn't. This comes with experience, but a good rule-of-thumb is to focus on information pertinent to a company's competitive positioning within the industry.

  4. The best investments you make are usually the ones where your get the most criticism. With investing, it rarely pays to be on the side of the cheerleaders. Indeed, some of the best investments I've made received initial criticism -- and the more passionate the criticism, the better; conversely, when I hear someone say "good call" about a recent investment, I start to wonder if I missed something important. Being able to stand alone in your convictions is a key ingredient to successful long-term investing.

  5. There’s no substitute for dividends. Despite the recent enthusiasm for "total yield" and similar measures that lump in buybacks and debt repayments with dividends, the bottom line is that only dividends put cash in shareholders' pockets today. None of the aforementioned successful investors that I worked with talked about how they were "living off their buybacks" and none of them manufactured their own dividends by selling partial stakes every quarter. That works in theory, but less so in practice.

  6. Process matters more than short-term results. Whether you're evaluating a mutual fund manager or reviewing your own strategies, short-term returns are largely a matter of luck rather than skill. Instead, focus on the investment selection process, as over time the process will have a more meaningful impact on returns. If you're going to review performance, pay closer attention to five-year returns as that's typically enough time to reveal the success of an investment strategy. Legendary investor Philip Fisher asked his clients for three years before they judged his results. Whichever time frame you prefer, the point is to not focus on quarter-to-quarter or even year-to-year results as a measure of investor skill.

  7. Keep costs to a minimum. The more capital you have to compound, the better. Some trading costs are unavoidable, but the key is to keep them to a minimum. A good rule-of-thumb is to keep commissions below 2% of each investment (e.g. invest more than $500 at a time if commissions are $10) -- and ideally much less. It's also smart to practice good capital location to keep a lid on tax costs -- i.e. to the extent possible, keep dividend paying stocks in tax-advantaged accounts like IRAs and your non-dividend paying stocks in taxable accounts.

  8. Actively seek feedback. Investing without feedback can slow your learning process, create or enable biases, and increase the odds of permanent losses as you're more likely to commit avoidable mistakes. If you can, find a trusted investing partner to run your ideas by -- and ideally one that isn't afraid to be critical and provide feedback. Even if you're confident in your abilities as an investor and think you can go it alone, consider the Warren Buffett/Charlie Munger partnership -- even the most capable investors of our time value the benefits of an investing partnership.

  9. Keep good records. A common denominator among the investors I admire is they meticulously keep track of each investment's thesis and their progress using spreadsheets and/or notebooks. The purpose of this exercise is to reduce biases that may skew your memory of why you bought the stock in the first place. Similarly, it can help you understand when the time is right to sell the stock.

  10. Read, think, and teach. Another common denominator among great investors is that they're bookworms. Sure, devour as many annual reports, investing books, and shareholder letters as you can, but you can also get valuable perspective from non-finance books. The Tao Te Ching, for example, provides some great insight about the value of patience. As you improve your knowledge base, don't forget that investing isn't an easy topic and there are many people seeking reliable answers. When its prudent -- and you know the answer -- don't shy away from opportunities to teach and help others become better investors. As the Roman philosopher Seneca said, "Welcome those whom you yourself can improve. The process is mutual; for men learn while they teach."

If you have any lessons to share from your investing experience, I'd like to hear them! Please share them in the comments section below or on Twitter @toddwenning. 


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