I was recently introduced to one investment concept that has a bearing on every single investors' life, but due to the difficulty in quantifying its impact on investment performance, it is largely ignored.
The concept I'm talking about is the idea of the investor's "brain drain." Not to be confused with the economic idea of a brain drain (losing highly qualified employees to different countries), the idea of an investor's brain drain is based on the fact every investor has to spend a significant amount of time and effort researching each opportunity.
The problem with overtrading
The more time and effort you spend researching each opportunity, the more of a drain it becomes (not to mention the psychological impact on your way of thinking). Studies have found the more time you spend researching an opportunity, the more likely you are to invest as it is a natural human impulse to seek compensation for time spent. Therefore, it is more likely you will bend the facts to compile an investment case that conforms to your initial thesis.
The vast majority of investment ideas you have will not pass the research stage. For those that do, there is no guarantee they will be a successful investment. Granted, there will be some winners, but the vast majority of ideas and investments you make over the course of your career will likely come to nothing. This is the brain drain in its full, ugly form. Professional investors can command a premium in fees because they spend all of their time researching and analyzing investments.
The average investor is not paid for such a luxury. Instead, they have to invest there own time and effort in finding the best opportunities, which, as noted above, is no guarantee of success at all. Quantifying this additional time and effort spent is not easy because it is difficult to place value on your personal time.
If you could add up all the extra time spent and place a value on it, then deduct this from your returns over the years, I believe these alternative fees would make you think twice about spending so much time analyzing businesses and overtrading -- what I believe is the principle cause of brain drain.
Mental models
I'm not saying individuals should give up investing altogether. Instead, I'm advocating a more focused approach with fewer stock positions, giving you more time to spend developing your knowledge both inside and outside the field of investing. After all, how are you going to find the next big thing if you are solely focused on individual companies without a broad-based understanding of the world and different industries?
This is similar to the approach advocated by billionaire Charlie Munger (Trades, Portfolio). He believes it's essential to develop what he's labeled an "elementary worldly wisdom" to succeed as an investor:
"What is elementary, worldly wisdom? Well, the first rule is that you can’t really know anything if you just remember isolated facts and try and bang ’em back. If the facts don’t hang together on a latticework of theory, you don’t have them in a usable form.
You’ve got to have models in your head. And you’ve got to array your experience – both vicarious and direct – on this latticework of models. You may have noticed students who just try to remember and pound back what is remembered. Well, they fail in school and fail in life. You’ve got to hang experience on a latticework of models in your head."
This requires a broad experience of the world to succeed:
"You must know the big ideas in the big disciplines and use them routinely – all of them, not just a few. Most people are trained in one model – economics, for example – and try to solve all problems in one way. You know the old saying: To the man with a hammer, the world looks like a nail. This is a dumb way of handling problems."
Conclusion
Overall, while the idea of a brain drain might not be a widely used concept in the investment world, I believe it is a good description for the time that is wasted searching for investment ideas that could be better spent improving your mental models. Holding a few select investments with a long-term horizon could be the best solution to the brain drain problem.
