I believe it's a mistake to think that all investors have have to do is pick winning stocks in order to get rich. That is just not the case. Picking winning stocks can help one get rich, but it is not essential. Picking a low-cost tracker fund and investing regularly is a strategy that is just as sensible, as it carries lower downside risk to compensate for the lower upside potential.
What's more, unlike picking stocks, which can be incredibly challenging and time-consuming, the passive tracker fund strategy requires little to no effort and is accessible to everyone.
Exceptional things
To borrow a phrase from Warren Buffett (Trades, Portfolio), in the world of investing, one does not have to do "exceptional things to get exceptional results." Doing something extraordinary can sometimes generate an outstanding result, but this is the exception rather than the rule.
For every investor who has completed an extraordinary trade, there's probably at least 10 others have tried a similar strategy but failed, whether it be due to the wrong timing, the wrong stock or another factor. Survivorship bias holds us back from understanding this critical point. With high-risk trades, many must risk and fail in order for one to risk and succeed.
Buffett explained this idea at the 1994 meeting of Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) shareholders:
"Some people think that if you jump over a seven-foot bar that the ribbon they pin on you is going to be worth more money than if you step over a one-foot bar. And it just isn't true in the investment world, at all."
At the time, the Oracle of Omaha was explaining why he tended to avoid investing in businesses he did not understand. Referring to Berkshire's Dexter Shoe business, he added:
"There's nothing that I know about that product, or its distribution system, its finances, or anything, that, really, hundreds of thousands — or millions — of people aren't capable of, that they don't already know. They just don't do anything about it.
And similarly, if you get into some complicated business, you can get a report that's a thousand pages thick and you got Ph.D.s working on it, but it doesn't mean anything.
You know, what you've got is a report but you don't — it — you won't understand that business, what it's going to look like in 10 or 15 years."
This is the challenge facing every investor: avoiding overly-complex businesses, which might look like home runs, but which they cannot understand. A critical point to keep in mind is that one will not lose money by sitting on the sidelines and waiting for an opportunity to come by. As Buffett put it in 1994, "The big thing to do is avoid being wrong."
Avoiding losses
One of the reasons why Buffett has been so successful throughout his career is that he has been able to avoid significant losses. Berkshire has booked large losses in terms of the total monetary value, but these have never exceeded more than 1% of net asset value in terms of the overall portfolio.
As Buffett's track record shows, avoiding losing money is one of the keys to generating wealth for the long term. The easiest way to lose money is to invest in something one does not understand. By flipping this statement on its head, is we can see the best way to avoid losing money, and that is to avoid investing in something one does not understand.
It is human nature to want to do something with one's portfolio. It is also human nature to look at the performance of other successful investors and want to try and copy it. However, one must understand that the odds are stacked against the average investor most of the time.
By understanding this principle, investors can focus on improving what they can influence and avoid companies they do not understand. This takes a lot of patience and self-discipline, although the results speak for themselves.
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