For most of us, the key to playing any sport well is to simplify the game, play within our abilities, and keep errors to a minimum. The same is true for long-term investing.

Golf is an apt comparison as relayed by Charley Ellis with the help of Tommy Armour:

Armour summarizes his years as a competitor, teacher, and student of the Great Game with a simple fact that undoubtedly will improve your scoring. “It is not solely the capacity to make great shots that makes champions, but the essential quality of making very few bad shots.” When Bob Hagin popularized “torpedo” stocks, he was making the same point. Imagine how investment performance could be improved by deleting any fund’s three or four worst stocks.

Like all great teachers, Armour repeats himself: “The way to win is by making fewer bad shots.”…

Armour goes on to explain his meaning with somewhat different words: “Play the shot you’ve got the greatest chance of playing well, and play the shot that makes the next shot easy.” Armour might change this advice a bit for investors to: Make the investment decision today that makes holding on for the long term easy.

Of course, improving performance goes beyond just removing a handful of bad performing stocks. Reducing emotional and biased decisions helps too. Maybe more so when it comes to holding on the long term.

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Quote for the Week

Many aspects of investing are fun, but your future wealth isn’t a game. You should manage it in the most cold-blooded fashion. Emotion, pride, ego, dreams, and nightmares have nothing to do with the process, although some investors rely on little else. It is in this sense that volatility really matters.

Many people pride themselves on being “long-term investors,” but acting deliberately when prices are bouncing around is not so easy. When stocks are blasting skyward, even the most steadfast can be sucked into the updraft. When they are cascading downward, keeping one’s cool is almost impossible. Volatility provokes the constant dread that some investors know more than we do, making us fearful of ignoring such powerful price movements…

I emphasize this psychological aspect of the matter, because those wonderful statistics on long-term returns are what the market did, not what any single individual or fund did, or would do, if history replayed itself. In my real-world experience, investors with smaller allocations to stocks and with some anchors to windward have been the ones most likely to be the winners over the long haul. The crucial element of success is the ability to make decisions without freezing up or slamming the panic button. In bear markets, the muted volatility and the contractual safety of bonds provide the most congenial environment for arriving at rational decisions about stocks. In bull markets, the balanced portfolio may not make for lively cocktail-party conversation, but with 60 percent in stocks, your wealth will still be participating and growing…

In investing, tortoises tend to win far more often than hares over the turns of the market cycle (and, as we have recently been reminded, markets still do have cycles). — Peter Bernstein (source)

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Quote for the Week

We deceive ourselves when we believe that past stock market return patterns provide the bounds by which we can predict the future. When we do so, we ignore the potential for future Black Swans.

The stock market has experienced relatively few of these extreme changes. And they are overwhelmed by the frequent—but usually humdrum—fluctuations that take place each day within normal ranges. For example, the Standard & Poor’s 500 Stock Index has risen from a level of 17 in 1950 to 1,540 at present. But deduct the returns achieved on the 40 days in which it had its highest percentage gains—only 40 out of 14,528 days!—and it would drop by some 70 percent, to 276. Or eliminate the 40 worst days; then, the S&P would be sitting at 11,235, more than seven times today’s level. A good lesson, then, about “staying the course” rather than jumping in and jumping out.

Financial markets, then, are volatile and unpredictable. Importantly, the markets themselves are far more volatile than the underlying businesses that they represent, which collectively account for their aggregate market capitalization. Put another way, investors are more volatile than investments. Economic reality governs the returns earned by our businesses, and Black Swans are unlikely. But emotions and perceptions—the swings of hope, greed, and fear among the participants in our financial system—govern the returns earned in our markets. Emotional factors magnify or minimize this central core of economic reality, and Black Swans can appear at any time. — John Bogle (Source)

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Sixty years ago, Warren Buffett bought control of Berkshire Hathaway. He’s highlighted that mistake on and off ever since.

He did so once again in this year’s annual letter, which came out over the weekend. Handling mistakes was the first of several lessons in his letter.

Quick to Fix Mistakes

Sometimes I’ve made mistakes in assessing the future economics of a business I’ve purchased for Berkshire – each a case of capital allocation gone wrong. That happens with both judgments about marketable equities – we view these as partial ownership of businesses – and the 100% acquisitions of companies…

A decent batting average in personnel decisions is all that can be hoped for. The cardinal sin is delaying the correction of mistakes or what Charlie Munger called “thumb-sucking.” Problems, he would tell me, cannot be wished away. They require action, however uncomfortable that may be.

No investor is perfect. Not even Buffett. Mistakes are part of the game. It’s a recurring theme throughout his annual letter going back decades.

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Quote for the Week

The really hard part about investment policy is not figuring out the best feasible combination. While it takes some time and analytical discipline, this part of the problem-solving is far from advanced science.

The really hard part is managing ourselves: our expectations and our interim behavior. Walt Kelly’s Pogo puts it as “we have met the enemy and he is us.” Most investors are too optimistic about the long run and much too optimistic about how well they will do compared to the averages, so they set themselves up for disappointment.

Even worse, most investors do harm to their longer-term investment results by trying and trying again to do better: changing managers and changing asset mix at the wrong time and in the wrong way. — Charley Ellis (source)

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