-- Charlie Munger, Berkshire Hathaway (BRK.A)(BRK.B)
It is also time consuming. It is hard to do it as a hobby, spending a few hours every week. Even if you have only 10 positions, keeping up with them is demanding.
On top of that, it is really difficult to find even one “sure” candidate. Of course, I can find a few incredibly undervalued opportunities. I can also find a few great businesses, which I see surviving and growing for a long time. But the intersection is almost empty.
The few positions I have, have either run up (and are not undervalued anymore) or are too risky to put new money into.
Starting a new position is not easy. One has to understand the business, look at the management, the risks, the competitors and then have the conviction to go through with the purchase.
Coat-tailing sometimes becomes very tempting. Especially when the company is selling for less than the price at which your favorite fund manager bought it. One is tempted to buy the stock and ride on the research done by someone else.
I do not have enough money to kick off my primary job and concentrate full time on my investments. I have been thinking about this problem for some time now. I do not claim to have the solution, but here is what I am going to do.
Prepare, Prepare, Prepare
When preparation meets opportunity, it results in success.
It is easy enough to understand but very hard to put into practice. It hurts to see the “sure” stock going up which you did not buy because you had no time to research it. It happened to me with Cisco (NASDAQ:CSCO). I was quite “convinced” that around $15 it was a great deal but I stuck to my guns and did not buy. By the time I finished some preliminary research on the management, the stock jumped from $15 range to $19 range.
People treat loss differently than they treat gain. When you are in loss you are prone to take more risk. On the other hand when you are in profit you are risk averse.
The situation is made worse because willpower is a finite and exhaustible resource. Research has shown that people who are asked to control their willpower will choose chocolate cake over a fruit salad (ego depletion).
These two biases come into play when you miss a “sure” opportunity. Immediately afterwards you are more prone to buy into a new stock without doing much research, if you think you are sure. The reasoning is as follows: I knew this stock was going to go up and it did! Now I am almost sure about this one too. I should buy it before it goes up.
The temptation gets worse with every new missed opportunity. Suppose that you missed the boat with Aeropostale (NYSE:ARO), which went from the $10 range in September 2011 to $20 range in April 2012. Then you missed it again with Cisco (NASDAQ:CSCO) which went from $15 to $20. And then you had the misfortune of considering USG Corp (NYSE:USG), a Buffett-owned company, which went from $7 range to $23 range. Think of how difficult it would be to not buy a new stock which you think is a sure bet (without doing the necessary due diligence)!
This brings me to my second point.
Know Your Weaknesses
Chinese wisdom has been trivialized by this whole fortune cookie gimmick. Sun Tzu, a Chinese general and military strategist, wrote a book called “The Art of War.” In it, he says the following:
It is said that if you know your enemies and know yourself, you will not be imperiled in a hundred battles; if you do not know your enemies but do know yourself, you will win one and lose one; if you do not know your enemies nor yourself, you will be imperiled in every single battle.
It is very important to know your weaknesses. The problem is that most investment books are investment-centric. To know our weaknesses, we need investor-centric books. We are fortunate to have the option of reading “Thinking, Fast and Slow” by Daniel Kahneman, “The Little Book on Behavioral Investing” by James Montier and a few others, but it is a shame that it is not mainstream yet. Introspection is the best inoculation against stupidity.
Just wait. I started buying stocks in October 2009. It was not investing — only buying stocks. It would have been much better for me to wait out for a year or two before jumping in. I should have read a few more books and given myself some time to assimilate the lessons. I remember reading a quote in my high school book:
"Nothing would be done at all if a man waited until he could do it so well that no one could find fault with it."
— Cardinal Newman
The quote warns us against inaction. Many things are learned by doing and probably investing is one of those things. If I had not got bitten by the downward spiral of Credit Suisse (CS), I would probably have avoided learning as long as possible.
What I suggest is to start with a smaller sum. Keep the 85% of your portfolio un-invested until you have proven yourself for a while. Maybe it will keep you away from substantial harm.
Wait Some More
Even when you know about how to find good stocks, it is important to wait for a good opportunity. It takes time for a major development to sink in. For example the bottom of the latest financial crisis was around Sept. 23, 2011, while the U.S. was downgraded Aug. 5, 2011. Similarly, the bottom of the credit default swap bust was in February 2009, a whole four months after Lehman's bankruptcy in September 2008.
After a crisis hits, do not jump with all your cash. Go slow. Take a deep breath and distance your buys over a few days.
The importance of cash cannot be overstated. Keep cash, always! You do not have to beat a benchmark. There is no point in being totally invested. My current portfolio is 46% cash after removing my put exposure, i.e. if all my puts were assigned, I will still have 46% of the portfolio in cash.
I would be happy to hear your distilled lessons in the comment section below.