How do you be a successful investor?
There's really no right or wrong answer to this question. If we look at some of the most successful investors of all time, from Warren Buffett (Trades, Portfolio) to Seth Klarman (Trades, Portfolio), Geroge Soros and Ray Dalio (Trades, Portfolio), each one of these individuals has used a different strategy to build wealth.
Buffett started off buying small deep-value stocks and then moved on to purchasing large, high-quality companies at Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial).
Meanwhile, Klarman has built a fortune buying and selling value stocks. He likes to buy undervalued securities with the view of holding them forever, but he is also looking for an upcoming catalyst that would crystallize value creation.
Soros likes to take large macro bets, and Dalio's Bridgewater employs a relatively complex strategy, using high levels of leverage and lots of small directional trades and hedges.
Each one of these investors has used different strategies to build wealth, and they've all been able to make these styles work. The point is, there's no correct strategy one has to use to make money. Anything can work, though all of these investors have followed a couple of key rules.
The most important of which is to avoid losing money.
Avoid losing money
When I first started investing, I misinterpreted this statement to mean good investors don't sell.
That couldn't be further from the truth. Good investors do sell and lose money, which is unavoidable, but what they don't do is compound losses by sticking with losers or doubling down on losing positions.
To clarify, this does not mean good investors don't average down into falling positions. That's fine. What isn't OK is doubling down on a position when a thesis is broken.
Billionaire investors have all had losing positions as well. It's how they reacted to them that helped them achieve the reputation they have today. As Peter Lynch once said:
"Some stocks go up 20-30 percent and they get rid of it and hold onto the dogs. And it's sort of like watering the weeds and cutting out the flowers. You want to let the winners run."
Successful investors monitor their investments on a regular basis. This does not mean keeping track of share prices every day. It means reviewing the company on a semiannual or annual basis to see if it is still performing as expected and in line with the investment thesis. The share price doesn't really come into it. If the company is performing as expected, there is no reason to sell. If it is not performing as expected, then it may become a weed.
The thing is, there are so many rubbish companies out there, but a very limited number of great businesses. It is far more sensible to stick with great businesses rather than chase rubbish companies. These great businesses are few and far between, but an investor only needs to own one or two to do pretty well throughout their life. As Lynch once noted:
"One of the oldest sayings on Wall Street is 'Let your winners run, and cut your losers.' It's easy to make a mistake and do the opposite, pulling out the flowers and watering the weeds."
These quotes from Lynch squeeze the argument into a few sentences.
Why would anyone remove the flowers from their garden and hope new, better ones arrive while leaving the weeds? The simple answer is they wouldn't. It makes far more sense to concentrate on getting rid of the weeds while leaving the flowers alone.
It's a simple example, but it is one that works. Great investment opportunities come along very rarely. It makes sense to take as much advantage of them as possible when they do.
Disclosure: The author does not own shares in Berkshire Hathaway.
Read more here:
- Peter Lynch's Advice From 1993 Is Still Relevant Today
- How Charlie Munger's Long-Term View Helped Him Navigate the Mid-70s Bear Market
- A Closer Look at Net Net Investment Richardson Electronics
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