The best thing I read this week is an article from Jim O’Shaughnessy on what it takes to be a successful active investor. He lays out the seven traits required for active investing.
But before he does, he covers the obstacle that gets in the way of most passive investors and why active investing is even harder.
Investors with passive portfolios—assuming they are adequately and broadly diversified—face only one real point of failure: reacting emotionally to a market selloff and selling their holdings, often near a market bottom.
But investors who use actively managed strategies face two points of failure:
- Reacting emotionally to a market selloff and liquidating their holdings, usually at the very worst time; and
- Selling out of an active strategy that is doing worse than its benchmark, often over periods as little as three years.
The second point of failure occurs even if the investor has earned positive returns in the active strategy—let’s say a gain of 10% per year over the last three years versus a benchmark return of 12%. While all investors face the same point of failure when selling during market swoons, only active investors face the second pitfall.
It’s absolutely true. You need to be all in on an active strategy or out entirely.
Choosing an active strategy brings with it the risk of strategy hopping. When one strategy doesn’t work as planned (quickly enough), it’s deemed broken. So it’s on to the next strategy, whichever performed best over the last few years. It’s just another form of performance chasing and being perpetually late.
The reason strategies don’t pan out quickly is the same reason Buffett’s strategy (value investing) has been called “dead” numerous times. Great strategies work over time, not all the time. Performance chasers don’t understand that.
Being impatient, short-term focused, reliant on predictions, noncommittal, and undisciplined leads to failure. Anyone matching that description is really hoping for luck.
Successful investors do the opposite. They’re dedicated. They’re in it full-time. They stick around when no one else will. Sticking around means they are early. In so doing, they reap the rewards other investors fail to capture.
If you only read one thing this week, it should be the Jim O’Shaughnessy article (linked below).
- Are Factor Investors Getting Paid to Take on Industry Risk? – Morningstar
- Investing is an Art, Not a Science – MicroCapClub
- Make Sure the Heated Steering Wheel is Worth It – The Art of Boring
- The Best Mutual Fund Discloser Ever – J. Zweig
- Business Advice From a One Year Old – M. Housel
- How Being Wrong Can Help Us Get It Right – T. Harford
- This Article Won’t Change Your Mind – Atlantic
- Will 90 Become The New 60? – Nautilus
- How the Internet Is Saving Culture, Not Killing It – NY Times
- Humans Made the Banana Perfect But Soon, It’ll Be Gone – Wired