Novel Investor

Compounding investing wisdom...

The Secret is Consistency

by Jon

In 1981, Pension & Investment Age magazine published their regular report ranking investment performance for pension plans. Alone at the top was a tiny bank based out of Chillicothe, Missouri.

Citizens Bank & Trust led the list of every bank- and insurance-managed pension fund for the 3-year performance mark. More importantly, it led the same list for the 10-year mark. How does a tiny bank in farm country Missouri beat out the biggest banks and insurance companies in the country for a decade?

The answer is Edgerton Welch. Welch was the 72-year-old chief investment officer for the bank who had never heard of Ben Graham or modern portfolio theory. He admitted to not being smart enough to play the stock market. He even said he had no idea if it would go up or down. Instead, he had a copy of Value Line and a simple set of rules to guide him.

Welch bought all the stocks that had Value Line’s highest ranking relative to other stocks, in industries ranked highly by Value Line, and also highly rated by Merrill Lynch and E.F. Hutton, the two brokerage firms he used. He held onto each stock until its Value Line ranking dropped. At which point he sold. Three rules tied to buying, one for selling. That’s it.

Some may point to the simplicity of Welch’s strategy as the reason for its success. They’re partially right. Continue Reading…

Peter Lynch on Common Investor Mistakes

by Jon

Peter Lynch was a legend who beat the market in a way few greats could do. From 1977 to 1990, he averaged a 29.7% return with the Magellan Fund. It was the best-performing fund of the 1980s.

And yet, Lynch made mistakes. He jokingly admits to it often. He just did mistakes better than most investors too. Lucky for us, he had a knack for simplifying the difficulties of investing.

His ability to cut to the heart of what it takes to make money, in the long run, is refreshing. And yet it’s still mostly ignored because the riches don’t come quick enough.

As a guest on Wall Street Week, in 1990, he explained why patience is key. It was one of several common mistakes he covered during the segment. Be it market timing, predictions, not knowing what you own, or lack of effort, the mistakes are universal. Lynch’s take is a good reminder of the trouble we can get ourselves into at times. Continue Reading…

Wise Words from Charlie Munger

by Jon

Charlie Munger is the lessor known half of the partnership team that built Berkshire Hathaway. Prior to that, he was a lawyer, before giving up law to run his own investment partnership.

He started Wheeler, Munger & Company in 1962. The partnership was wound up in 1975. Back-to-back 31% losses in 1973 and 1974 made investors squeamish and in need of capital. Yet, despite the losses, Munger outperformed the market, earning a 19.8% annual return over the 14-year period (compared to 5% for the Dow).

Munger teamed up with Warren Buffett three years later (1978) as vice chairman of Berkshire. In his spare time, he chairs the Daily Journal, designs buildings, and plays the part of a walking, talking encyclopedia. He’s a learning machine who built his own system of mental models to reduce errors in this complex world. His unique view of uncommon sense, as he calls it, can be seen in how he invests.

Extreme concentration and inaction best describe Munger’s approach. He’s comfortable with only three or four wonder businesses in his portfolio. That’s far short of the popular broad diversification strategies recommended today.

Except, extreme concentration is not for everyone. First, finding a handful of wonderful companies worth owning is never as easy as it sounds. Someone not skilled in the art is likely to find awful companies more often than wonderful ones. Continue Reading…

Skill vs. Luck: Failing to Lose

by Jon

Purposely losing money in the stock market seems like it should be an easy task. It turns out it takes some luck to lose money in the market. The same goes for making it.

Michael Mauboussin defines pure skill-based activities as those where you can lose on purpose. Chess is pure skill. It takes years of learning and practice to become just good at chess. However, a master chess player can lose on purpose to anyone.

Whereas the lottery is pure luck. It’s a random draw. You can pick a series of numbers and hope to lose but there’s always a chance you get lucky and win.

Investing falls somewhere in between pure skill and pure luck because the amount of noise in the system makes it hard to lose (or win) on purpose in the short run.

A good example of this is an interesting experiment run by John Rogers and his team several years ago: Continue Reading…

Edwin Lefevre: Investor, Speculator, or Gambler?

by Jon

Ben Graham often explained the difference between investors and speculators.

An investor looks for investments that provide safety and a solid return. A speculator tries to profit off market moves.

Edwin Lefevre had a similar view. Though, he added a third option for good reason. He separated gamblers from speculators because he saw a pattern of gambling emerge during bull markets.

Here’s how he defined each following the 1929 crash: Continue Reading…

Learning the Wrong Lessons

by Jon

There’s a risk that investors learn the wrong lessons from recent market cycles. One of the biggest wrong lessons is that the market always quickly recovers.

Of course, quick recoveries have defined the stock market since the 2008 financial crisis. The 2009 bottom led to the longest bull market ever and the buy the dip mantra (BTFD) grew from that period. The 2020 crash solidified it.

It would come as no surprise if investors expected recent history to repeat itself. Of course, investors often mistakenly rely on recent history or lived experience to make decisions, as if it’s the only history that matters.

In fact, Seth Klarman noted this specific false lesson in 2010:

Bad things happen, but really bad things do not. Do buy the dips, especially the lowest quality securities when they come under pressure, because declines will quickly be reversed.

Howard Marks shared a similar thought in his book Mastering the Market Cycle: Continue Reading…

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