This isn’t an article for traders. It’s meant as advice for long-term value investors.
I’ve been reading Howard Marks’s The Most Important Thing. This got me thinking about risk. And how I don’t talk about risk enough on the blog.
I don’t want to talk about risk in theory. I want to focus on the practical risks value investors – especially long-term value investors who focus on picking specific stocks – face each and every day.
How do value investors screw up?
How can they have the right philosophy and yet implement it so badly, they actually lose money in some of their investments?
One way is to buy and sell stocks at the wrong times. I’ll talk about that tomorrow. Today, I want to talk about the umbrella category that falls under: acting like everyone else.
It’s risky to act like everyone else.
And one way investors can act like everyone else is by looking at the same stocks everybody else looks at.
Another way is by entering and exiting stocks along with the crowd.
Both are risky mistakes.
How Mutual Fund Investors Manage to Do Worse Than the Funds They Buy
Mutual fund investors are masters of bad timing. Usually, they are pretty good at knowing what fund is best. It’s no secret that Bruce Berkowitz is a good investor. But even investors who know that – and who therefore trust Berkowitz with their money – manage to destroy the profit potential in partnering up with a superior investor.
Morningstar keeps data on just how bad mutual fund investors are when it comes to timing their entrances and exits. For example, over the last 10 years, Bruce Berkowitz’s Fairholme Fund (FAIRX) has returned 9% a year. The average Fairholme investor has earned just 1.7% a year.
New money enters the fund just before performance goes bad. And money exits the fund just before performance turns right back around.
I’ll talk about the issue of terrible timing in another post. Today, I just want to use this terrible timing as evidence. It’s evidence that following the crowd is not safe.
Following the crowd is so risky that even if you are right about which fund manager to invest with, you can be wrong enough in your entrances and exits that you fritter away 7% a year on nothing but needless activity.
Does the Average Investor Really Match the Market?
I’ve never believed this for a second. The truth is that if you can find an entirely arbitrary allocation (50% bonds/50% stocks) or a hedge fund or a program or system or whatever that keeps you invested enough at all times in good enough assets – you’ll do better than most investors.
Most investors think their problem is figuring out what assets have the best long-term returns, which managers are the best investors, and what approaches to investing work.
Investing is More about Practical Psychology than Theoretical Efficiency
My constant contention has been that investing is …Read more