Not-to-Do List: Become a Better Investor in 2019

By Amit Rupani

Charlie Munger, vice-chairman of Berkshire Hathaway had a simple advice to offer when asked on how to get successful in stock market. He said “It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent." So, if we know what not-to-do and be disciplined in never making the stupid mistake, we have a very big edge over many undisciplined, intelligent investors. As we enter the New Year 2019, I wanted to share a small “not-to-do" list that can help one become a better investor.

Swinging for fences: In the Dutch Republic, at the peak of tulip mania in February 1637, some single tulip bulbs sold for 10 times the annual income of a skilled craftsman. Tulip mania is considered as the first recorded speculative bubble where prices for tulip bulbs reached extraordinarily high levels and then dramatically collapsed. We had Bitcoin mania in late 2017. It was on 17th of December 2017 that Bitcoin reached a high of $19,870 and later collapsed. It is currently trading at a meager $3,590. I won't be surprised if Bitcoin is worthless in the future. There were many who swung for the fences and joined the Bitcoin mania only to be disappointed later.

There's an old proverb that says, “The best time to plant a tree was 20 years ago. The second-best time is now." In a world that is full of instant gratification, the natural process of growing fruit trees may seem like an eternity. But there are no short-cuts to success in investing. Wealth is created through investments with the power of compounding and the actual magic of compounding is back-loaded, which requires years of patience. If while attempting to swing for the fences, we get out and lose the game (lose invested capital), we need to start again from zero. We know how hard it can be to start everything again from scratch. Here's an apt Warren Buffett rule, “Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1."

Panicking when markets are down: It is the nature of auction driven markets to swing to absurd levels on both upside and downside. During bearish periods, market participants feel that bad times will continue forever and push prices to irrational lower levels. The opposite happens during bullish times as market participants predict good times forever. But the reality is that economy moves in cycles. It goes through its up move to reach its peak level and then makes its way down and creates a trough to start a new cycle. As we know such cycle takes years to complete its full circle. Stock market just stays a step ahead of the economy cycle as it attempts to foresee where the economy is headed and moves accordingly. Stock market heading only in one direction is unsustainable.

Isn't there a saying – buy low and sell high? But unfortunately, many retail investors do the opposite. They get panicky and sell at low prices when markets fall and buy when market is about to top. If you are an investor with long-term investment horizon, it is in your best interest for the markets to fall in the medium-term, so that you can buy at ridiculously low prices. Generally everything is available on sale when there is panic in the market. Great to mediocre level companies, all of them get marked down. One should not be buying mediocre business at bargain price, but great business at bargain price. You would not want to shop at Dollar Store on Black Friday. Smart investors keep enough cash and shopping list of great businesses ready to make best use of panic days in the market. Apt quote of Warren Buffett for investing and stock markets in general, “Be fearful when others are greedy and greedy when others are fearful."

Have all your eggs in one basket: Many people understand that putting 100 percent allocation in a single stock is bad idea. However, allocating 10 percent investment in 10 different bank stocks is also not a good idea. The goal should be to not only diversity at the individual position level but also at industry level. An ideal portfolio should have appropriate mix of exposure to various industries. Consumer staple stocks can provide much required support to the portfolio during recession times, while cyclical stocks can outperform market indices and increase portfolio return during a bullish market period. It's very easy to believe that we can overweigh consumer staples before market falls and overweigh cyclicals before market rise. But the truth is no one can time the market. The sentiments in the stock market signal have only two lights; red and green. It doesn't have an amber light. Here sentiments switch only between red and green and it can change at any moment. Hence, the saying is very true that it's impossible to time the market consistently.

Investors should also manage their overall portfolio spread across various asset classes like stocks, bonds, real-estate, etc. There is also such a thing as “over-diversification". When adding additional investments to a portfolio, each additional investment lowers risk but remember, lower risk = lower return. Over-diversification occurs when an additional investment lowers the potential return more than it offsets the potential risk. Take for example Pepsi and Coke. The companies are similar in a number of ways so rather than buy both, rational decision would be to buy the company that presents the best value. Over-diversification is not only time consuming and inefficient, trading commissions on a large number of investments can be quite costly which may ultimately reduce your overall return.

Happy Investing!

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Amit Rupani, CFA is an Independent Investor, practices Value Investing principles, manages money for long-term wealth creation through Equities asset class. Email: rupaniamit@yahoo.com