Finding good investment ideas can be incredibly challenging. Wall Street constantly tries to pressure investors into adopting flashy new ideas. The media is always trying to present new ideas to investors, and let's not get into things like the string of conferences that take place throughout the year and financial magazines.
All of these present a tidal wave of new ideas to investors. It can be challenging to navigate through the noise and find good ideas, especially when there is so much noise. New investors may be completely overwhelmed. I know I was when I first started investing. There were so many stocks being recommended, I often jumped in and out of positions after only a week or two of ownership.
Luckily, this phase didn't last very long for me, but it is all too easy for investors to become overwhelmed and distracted by the sheer volume of ideas out there. There are a couple of strategies investors can use to deal with this noise. The first strategy is one that has been advocated by billionaire investor Warren Buffett (Trades, Portfolio).
Say no and stick to the best ideas
The Oracle of Omaha has said in the past that the best investors say no to almost everything. This means the best investors only concentrate on ideas that fall inside their circle of competence. Everything else should be ignored. The best way to determine if something falls inside a circle of competence is to ask if you understand the company and its industry. If you don't, it does not.
Another strategy is something renowned value investor Mohnish Pabrai (Trades, Portfolio) advocated in a talk at Alphabet's Google (GOOG, Financial)(GOOGL, Financial) in June 2017. Pabrai highlighted a story Charlie Munger (Trades, Portfolio) had told him regarding the Capital Group's Best Ideas Fund. The idea of the fund was to gather a selection of the asset manager's top portfolio managers and ask them to present their best idea for the fund. Unfortunately, the fund did not perform well.
As Pabrai explained, the problem was that the ideas included were not necessarily the best ideas but simply the ideas that managers had spent the most time on. As he stated:
"Charlie said the best ideas fund was simply a fund full of ideas which managers had spent the most time on, the ideas they were most excited about."
These managers had fallen into the classic trap of thinking they knew a lot about the business just because they had spent a lot of time studying the opportunity. However, once they had committed themselves to it, it wasn't easy to turn back.
Therefore, the strategy Pabrai advocated in 2017 was to avoid spending too much time looking at businesses. Instead, he stated that if an idea was not immediately apparent, it should be avoided. Otherwise, there will be a risk that the investor looking at the opportunity spends so much time looking at the stock, they will convince themselves it is a good business.
These two strategies can help investors improve their decision-making process. They can also help investors avoid stocks they may not understand, which could otherwise cause losses.
I want to end this article with a quote from Pabrai's talk in 2017, in which he explains a series of psychological "hacks" investors can use to remove psychological biases:
Also check out:"The first hack is being aware. Just being aware of these facts is a huge advantage. So being aware of the fact that we have a lot of biases, and our mind can play games and tricks on us. Being aware of that and being rational. Charlie Munger (Trades, Portfolio) often says that he isn't successful because he's smart, he's successful because he's rational. Another approach is to be fluent in the other side of the argument. If you are going to be long a stock, it's probably worth putting together a thesis of why you should go short. That will force your brain to think about things that it does not normally want to think about."
