“How long has your guru been teaching?”
“Well, uh, over thirty years…”
“And how many of his students have achieved enlightenment?”
“Well, uh…”
“Don’t you think they should have, like, an entire army of enlightened guys to show off by now?”
From ‘Spiritual Enlightenment: The Damndest thing’
By a rough estimate, there are over 1000 books on “How to pick perfect stocks”—at least 100 of those with lifetime sales figures in the hundreds of thousands. Even with overlaps, that’s a few million successful investors who know exactly what stocks to pick to build life-changing wealth from equity investing.
Weirdly, it’s incredibly difficult to bump into many successful investors.
Just like it’s hard to come across many healthy, fit individuals even though “how to lose weight” books sell in the tens of millions.
Literature on investing has a problem—Scratch that. Literature on investing has many problems. But one among them is the focus on cherry-picked narratives and hindsight bias.
This and hence one of my all-time favourite quotes.
“In theory, there is no difference between theory and practice. In practice, there is.”
Yogi Berra – successful professional baseball player, manager and coach
The Art of Execution: How the world’s best investors get it wrong and still make millions by Lee Freeman-Shor is one of the few investing books focusing on how successful investors differ from the rest in how they deal with losing and winning portfolio positions.
The book is based on the author’s experience of having overseen many investment managers of varying styles managing his fund’s (Old Mutual Global Investors) money.
Specifically, it draws conclusions from 1,866 investments over seven years, representing 30,874 trades made by 45 of the world’s top investors. Each of the 45 investors allocated between $20 and $150 Million on behalf of the author’s fund.
However, it is far from a comprehensive review of the topic. It has a problem of too many anecdotes and not being MECE (mutually exclusive, collectively exhaustive) in its coverage of all scenarios. The section on dealing with losers feels more thought-through than the one on winners.
But its value is that it uses data to talk about two essential but ignored investing truths:
- Even successful investors are wrong, a lot
- They make more money when they’re right than what they lose when they’re wrong
First, the shocker: More than half (51%) of all those investments lost money. Literally a coin toss. Remember, these are decisions by an elite group of investors with solid track records.
However, overall, almost all of the investment managers did NOT lose money.
Hence, the author asserts that successful stock market investing is not about being right but how you execute your ideas.
You don’t even have to worry about whether an investing idea works or not if you focus on how to invest in that idea: how much money to allocate to it and what you will do when you find yourself in a losing or winning position.
The book is organised into two parts: “I’m losing – what should I do?” and “I’m winning – what should I do?” Within each part, he breaks down the investors he analysed into groups and how the groups with winning records differed from those with losing records.
I’m losing – What should I do?
You identify a potential winning theme, go into the annual report footnotes, and read all the reports you could lay your hands on. Then you buy. But it doesn’t go as you expected. Soon your investment is under water. What do you do?
We intuitively know losses hurt far more than the pleasure from gains of the same magnitude. And so, dealing with losing positions is one of the hardest things investors must do.
Rabbits
Rabbits freeze when facing losses. Least successful of the groups facing losing positions.
Buy stocks that fit the profile of their favourite investments, e.g. “blue sky stocks”, that might become the next big thing. And when those stocks lose money, they adjust their mental story, so the stock still looks attractive.
Tend to fall in love with their stocks, anchor to one view and one price and underreact to bad news. They tend not to like being wrong or admitting they’re wrong. Rather than admit a mistake, rabbits tend to externalise causes, like “Mr Market is being stupid” or “it would have made money but for this unforeseen event”. When they go seeking further information, which they can from senior sources, it is invariably to confirm what they feel.
Another interesting reason for their reluctance to act when facing a significant loss is the size of the position. The bigger the losing positions, the more nervous and indecisive most of us become.
How not to be a rabbit:
- Always have a plan: Know the difference between the conviction to continue holding and avoiding the pain of deciding to take a loss
- Sell or buy more: You’re wrong, or the market is wrong. Decide which. Doing nothing shouldn’t be an option
- Don’t go all in: To be able to buy more if it falls, you need some powder dry
- Don’t be hasty to jump in, do be hasty to jump out
- Seek out opposition: What do smart people with an opposing view have to say?
- Be humble: Remember LTCM “10 or 15 guys with an average IQ of 170 got themselves into a position where they lost all their money.’
- Stay quiet: Talking about your investments publicly makes it harder to walk away from them.
- Don’t make excuses: The most common ones are “If only,” “I was right had this not happened”, and “Who could have foreseen.”
Assassins
Assassins live the Warren Buffett maxim of “never lose money”. Assassins are ruthless about selling losing positions to preserve their capital. Like Stanley Druckenmiller said of George Soros, “the best loss taker I have seen”
Tend to operate by rules framed well in advance instead of relying on themselves when markets go against them.
What assassins do:
- Kill all losers at 20 – 33%: Operate with stop-losses and follow them without question. The actual levels vary by investors depending on their style; of the 946 losing investments, 557 (59%) made money after they were sold. However, of those 557, 205 returned less than 20%, which would not cover the losses. Therefore, overall, 66% of losing stocks were better off being sold than being held on to
- Kill losers after a fixed amount of time: Over the long run, time corrections are the same as price corrections. Assassins sell stocks which went down by any amount and showed no signs of recovery after a certain time.
Being careful on the next investment: A potential downside to selling out of a losing stock is seeking more risk in the next stock. Being comfortable holding cash while waiting for the next opportunity is a superpower.
Hunters
Do the opposite of Assassins, buy more when their positions fall, then wait for it to recover. Hunters typically have had terrible years at the start of their careers, losing a lot of money, making them contrarian investors.
If the stock passes the “Would I buy this knowing what I know now?” test, Hunters buy more of a stock that has fallen from its initial buy price. They also tend to be significantly allocated to their positions, like Warren Buffett investing 42% in American Express in 1974 after its infamous salad oil fiasco.
Being a good Hunter is hard since it requires the stomach to hold on to fallen stocks and deploy more capital.
The message is clear: Be an Assassin or a Hunter when dealing with losing positions; don’t be a rabbit.
I’m winning – What should I do?
Raiders
Raiders do not let their winners run and take small profits on all their winning positions.
They have self-control issues. Promise to go to bed early, stick to their diet and not drink too much but end up staying out until 3 am, having extra helpings of dessert.
A variety of factors like Fear, Boredom make them short-term focused. Raiders are often Rabbits when losing—i.e. selling winners early and holding on to losers.
Connoisseurs
The most successful investors in the study cohort did not get paralysed by unexpected losses or carried away with victories.
Their way of dealing with winning positions was often to take small bites and leave the rest for later. But they won big when they won.
Their approach was to:
- Find unsurprising companies: Companies that can be expected to grow revenue and earnings for ten years
- Look for big upside potential: Instead of investing in many ideas with limited upside, they invested big on a few ideas.
- Be boring: Tended to stay invested for five years or longer
Successful connoisseurs tend to be Assassins or Hunters with losses.
In closing, the author says
Success in investing is open to anyone, whatever their background, if you have the discipline to materially adapt when losing and remain faithful when winning.
Read The Art of Execution: How the world’s best investors get it wrong and still make millions by Lee Freeman-Shor.
Other reading:
Where do superhero stocks come from? – Our analysis of 1,000+ stocks to understand stocks that have gone up 10x in 10 years
Common-sense position sizing for investors – A framework to think about how to allocate
How Happy is your Money? Review of Happy Money by Ken Honda
