Seth Klarman (Trades, Portfolio)'s 2018 letter to investors is full of warnings and advice about how to invest in a turbulent environment.
As I covered in my previous article, the part of the letter that has attracted the most attention so far is Klarman's warning about the excesses of capitalism and what might happen to the global economy if another financial crisis breaks.
The highly regarded value investor does not try to place a date on the next crisis; he says only that investors should be prepared for the worst as policymakers struggle with economic policy, and trade wars drive down economic growth.
In his letter, Klarman also spent some time laying out his thoughts on what he describes as the "proper wiring for a long-term investor."
Investor psychology
This is a topic that the "Margin of Saftey" author has covered many times before, but his advice on the subject never gets old. It is always fascinating to listen to and read about what Klarman has to say, and even more so when it comes to the psychological aspect of investing.
"It would be a serious mistake to think that all the facts that describe a particular investment are or could be known. Not only may questions remain unanswered; all the right questions may not even have been asked. Even if the present could somehow be perfectly understood, most investments are dependent on outcomes that cannot be accurately foreseen." -- Seth Klarman (Trades, Portfolio) in "Margin of Safety"
In his letter, he compared investors to the relief pitcher in baseball.
These players are drawn into the game after the starting pitcher is removed due to injury or for some other reason. They have to take over, usually for several innings, and try to hold the game together. This role is not easy for many different reasons, one of which is that relief pitchers expose themselves to what Klarman calls "major psychological trauma."
What he is referring to here is the trauma of messing up a good game. Everyone remembers the relief pitcher who cost them the game, but few will give the pitcher credit just for doing their job. No matter what happens, the pitcher is unappreciated. Despite this, they have no choice but to forget the mistakes and move on. Every game is different, and they need to be at their best no matter what has happened in the past.
Investors face the same psychological problems. If you make a mistake, it can be costly, but it is vital not to let these errors carry on to your next investment decision. You need to learn your lesson and move on -- what has happened has happened, Klarman told his audience.
This is the proper mindset for the long-term investor. Baupost's manager opined that to be a successful long-term investor, you need to concentrate on each opportunity as if it were a new one, and not let past mistakes cloud your judgment, particularly when Mr. market is deciding the prices for stocks. Getting caught up in Mr. Market's daily price gyrations will influence your decision-making ability for the worse, and stop you from acting in your best interests.
Hard work required
"Value investing requires a great deal of hard work, unusually strict discipline, and a long-term investment horizon. Few are willing and able to devote sufficient time and effort to become value investors, and only a fraction of those have the proper mindset to succeed."
Relief pitchers train hard, put in the work and have to wait for the perfect opportunity to strike. The same is true for value investors. A great deal of hard work and strict discipline will pay off, although, along the way, you need to be prepared to suffer psychological trauma.
The best way to deal with this trauma is to get up, dust yourself off and move on. That's how Klarman seems to deal with his mistakes, anyway.
Disclosure: The author owns no share mentioned.
