The best investors are masters of subtraction. They played the game long enough to simplify their investment philosophy down to a few key principles. And it did wonders for their portfolio.
The goal of investing should be to eliminate things that have a high probability of producing losses. These are things that you know won’t work. Things you don’t understand well. Things that are too complex. Things that are distractions and noise. Things that lead to mistakes. Things that are irrelevant, unimportant, and unnecessary to your process. Anything that doesn’t fit what you’re trying to do should be cut out.
The problem for most investors is we know none of this when we start out. Each one of us must go through the slow and sometimes painful experience of figuring it out.
Yet the idea of improving things by subtraction flies in the face of human nature. Our typical response to problem-solving is to make things more complex. Addition is our default.
In a series of studies by Adams, Klotz, et al, the overwhelming result was to add rather than subtract features to solve a problem.
The paltry rate of subtraction in our organizational-improvement study was no fluke. We observed similarly low rates of subtraction across multiple tasks. To improve a redundant piece of writing, few participants produced an edit with fewer words. To improve a jam-packed travel itinerary, few removed events to allow them to savor the ones that remained. To improve a Lego structure, almost no one took pieces away. Whether people were changing ideas, situations, or objects, the dominant tendency was to do so by adding.
In fact, solving the problems via subtraction wasn’t seriously considered until participants were given a hint that they could add or subtract. The option to improve something by simplifying it was never considered.
A bias toward addition isn’t good for investors either. It would explain bloated portfolios, complex strategies, and more.
And yet, the best investors followed the opposite path. They spent a lifetime learning what doesn’t work and avoided it. Those lessons were then encapsulated in their simplified philosophies. The similarities of those philosophies reside across three key areas.
Investing starts with patience. The market has its own timetable that rarely synchs up perfectly with ours.
When things don’t happen immediately with an investment it’s easy to get frustrated, think something is wrong, and give up on it. The investment gets replaced with something else and the process repeats itself. The worst-case outcome is impatience that spirals into trading early and often that magnifies losses.
Maybe a greater risk of impatience is having a strategy that works only for the opportunities to dry up. Then investing becomes a game of who flinches first. Will the market give up opportunities or will you, the investor, lower your standards? The risk is that you end up with a portfolio full of sub-par investments that you would have instantly said no to in the past. Unfortunately for the impatient investor, most investments take time to work out. Strategies do too.
The advantage of patience is the ability to ignore the short-term nature of markets. The noise, the forecasts, what others are doing, the lack of opportunities, etc. are nothing more than distractions for the impatient but opportunities for the patient investor.
Patience and consistency are common threads linking great investors. They seem almost unwavering in their ability to wait.
Stay humble. Markets can build your confidence and crush your hopes all in a matter of months. If you play the game long enough, there’s no escaping it. Markets spare no one. Being humble about that fact is one of the best defenses against it.
The key is knowing the role luck plays in investment results. The fact that people make a fortune on horrible investments is proof that luck exists. The same is true of great investments that lose money. Beating practically impossible odds happens sometimes but it makes for a horrible investment strategy.
The best investors know that unlikely things happen but it’s not the norm. So they focus on strategies that tilt the odds in their favor in the long run.
Humility brings the added bonus of knowing what you don’t know. So the best investors focus on areas they know well, with investments that are simple to understand, while also constantly expanding their knowledge.
Risk first. Some of the biggest investing mistakes would be avoided if investors prioritized risk. What does that mean exactly? A quote by Joel Greenblatt in Richer, Wiser, Happier explains it well:
You size your positions based on how much risk you’re taking. I don’t buy more of the ones I can make the most money on. I buy more of the ones that I can’t lose money on.
Most investors do the opposite. Anything that offers a big win grabs our attention.
Lottery stocks, story stocks, fads, leverage, options, and more have the potential to produce huge returns but carry huge risks. Which, more often than not, become losses. Betting too much of your portfolio on extreme returns likely ends in disaster.
The best investors almost universally look for a reason to say no to an investment. And they say no a lot. It’s the key to their longevity. A risk-first approach positions your portfolio for survival.
This post was originally published on February 9, 2022.