Novel Investor

Compounding investing wisdom...

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…

Wise Words from Charley Ellis

by Jon

Charley Ellis recognized that there were two different games being played in the stock market. The game the experts play differs from the game the amateurs play.

When the amateurs try to play the experts’ game they frequently make mistakes and lose money. That’s not to say the experts are fantastic at making money. A few are but experts, on average, fail to beat the market too. So the majority of experts fall short of the market and the amateurs, emulating experts, do worse.

Ellis’s solution is to play a different game entirely. The game amateurs should play, and many experts too, is built on a foundation of avoiding errors. Essentially, not losing. Fewer errors lead to better results.

Ellis wrote this in his 1975 classic The Loser’s Game. In it, he used an analogy between tennis and investing. It turns out there are two different games in tennis too. The game the professionals play is not the same game as the one the amateurs play.

The pros can be aggressive. They have the skill, precision, and experience to place shots just outside their opponent’s reach. They play a winner’s game. The match goes to the player who earns the most wins.

Amateurs, however, often lose by trying to play like the pros, because it leads to unforced errors. It’s a loser’s game. Amateurs win in tennis by volleying until their opponent hits it into the net or out of bounds. They win by not losing. Continue Reading…

Phil Fisher: The Art of Holding On

by Jon

Selling is the more difficult part of investing than buying. Holding on is even harder.

Phil Fisher had a philosophy around selling — or rather, not selling — that may be helpful to more than his stock-picking fans. But first, a little background.

Fisher was the original long-term investor. He just did it in a very highly concentrated way, a side effect of his strategy.

He’s the guy that influenced Warren Buffett’s transition from Ben Graham’s buying companies at a wonderful price to Buffett’s wonderful companies at a fair price. The key change was essentially paying a higher multiple (but still undervalued price) in exchange for a longer runway.

That last bit is key.

Fisher’s philosophy is built on finding the handful of companies that can grow at a sustainably high rate over long periods of time. While the typical Graham investment might have a holding period of one to three years, Fisher’s was decades. Continue Reading…

Investing Advice from 1937, Still Relevant Today

by Jon

Fred C. Kelly wrote an almost weekly column for Barron’s from December 1936 to June 1937. It was well-timed.

His column began near the tail end of a four-year bull market. The stock market bottomed in June 1932  — June 8th for the Dow at 41.2. Then it took off. The next four years saw the Dow rise 337% off the bottom.

However, 1937 would end that run with a 33% loss on the Dow. The Dow hit a high for the year on March 10th, proceeded to decline 15% over the next three months, then almost recovered completely. The ’37 crash hit two months after his column ended.

Kelly’s column offered some well-timed behavioral advice that happens to still be relevant today. Continue Reading…

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