The five most important lessons from 30 years of investing in stocks
The stock market bug first bit me in 1990. I became obsessed with analysing companies and predicting whether the price of their stock would go up, down or sideways. I devoured annual reports, financial newspapers and magazines and books on investing.
Back then, I did what conventional wisdom advised: put my money in managed funds. But when the spreadsheet I'd built on my state-of-the-art DOS computer revealed how much I'd pay in fees over the next 40 years, my jaw hit the ground.
There had to be a better way. So, I put my computer science and mathematics degree to work and spent more than 2500 hours working on the solution. What follows are the most important lessons I learned along my investing journey. I hope they help you with yours.
1. Begin with the end in mind
Henry Kissinger once said, "If you don't know where you are going, every road will get you nowhere."
Having a plan in place before investing even one dollar into the market is a must. This single action will help you stick to your guns when the 24/7 noise of analysts, geopolitical angst, and latest hot tips try to steer you astray.
When I was young, I had lofty goals of beating the market by double digits. But with my homemade spreadsheets on hand, I soon realised that even modest returns will compound nicely over time.
The miracle of compounding is quite real. If you set a goal of beating the market by between 2% and 5% annualised (meaning, averaged out over the years), you'll be on track for a comfortable retirement.
2. Investment mistakes compound
This could be the most painful lesson. People assume compounding only works for you but it can work both ways.
Here's how I've watched compounding burn investors over the years:
- Managed funds and financial adviser fees
- Being fully invested during downturns.
Let's start with the fees. John Bogle, founder of Vanguard, put it best. He said: "The investor, who put up 100% of the capital and assumed 100% of the risk, earned only 31% of the market return. The system of financial intermediation, which put up 0%of the capital and assumed 0% of the risk, essentially confiscated 70% of that return—surely the lion's share. What you see here—and please don't ever forget it—is that over the long term, the miracle of compounding returns is overwhelmed by the tyranny of compounding costs."
The second way compounding can hurt investors is the impact of downturns on their portfolio. Over the lifetime of most investors, they will experience an average of six major market corrections (meaning, drop of 35% or more in the overall market). While the market recovers over the long term, the average portfolio won't perform as well as if it had been sheltered from the loss. Keeping the bulk of one's portfolio safely in cash during these times opens up a host of opportunities for better returns over the long term.
3. Value investing is broken
There is no denying Warren Buffet's returns. But they are anything but effortless. Over the course of his 65+ year career, some say Mr. Buffet has spent well over 100,000 hours studying companies, financial filings, balance sheets, microeconomic and macroeconomic trends and more.
This approach is called "value investing" or "fundamental analysis". Like so many investors, I defaulted into this during the first five years of my investing journey. I poured over balance sheets and earnings reports, even going so far as to purchase data on company fundamentals.
But then, the bear market of 1994 hit. And right along with it came a 22% drop on the ASX. How had I not seen this double-digit decline coming? I had spent nearly every waking moment studying the market's ebbs and flows. As it turns out—when you don't also consider price movement—timely and objective decision-making is impossible.
4. The stock market is not the economy
You've probably noticed that stock markets around the world are reaching new highs, despite that cases of COVID-19 are doing the same. Morally this doesn't add up. But Mr Market doesn't care. And that's another tough but important lesson to digest.
Consider the S&P 500. This index tracks just 500 companies. Meantime, there are more than 32.5 million businesses in the US. According to the National Bureau of Economic Research, "Publicly traded companies constitute less than 1% of all US firms and about one-third of US employment in the non-farm business sector." Australia has a similar makeup.
That's why the economy and the stock market are not in sync; they've never been in sync and they never will be in sync.
5. Responding is better than reacting
The final key I want to share with you is, whatever you choose, do it consistently. Market volatility is as reliable as death and taxes. Instead of trying to catch a falling knife, use a method that allows you to listen to the market and respond accordingly.
I use a system that I set up over the course of my investment lifetime. This has allowed me to overcome the many obstacles I've encountered: the subjectivity of trading, the massive time commitment and the unreliability of value investing.
The chart below shows the outcome of one of my portfolios. The system delivered just under 100 "buy" and "sell" calls during the course of the 4.5 years shown. This resulted in outperforming the broader market by 10.2%, annualised.
The dark-blue line is my portfolio's return: 17.5% annualised (January 2016 to June 2020). The light-blue line is ASX200 Accumulation Index: 7.3% annualised.
I achieved these returns using my investing algorithm, which has become my go-to investing strategy. The beauty of a system like this is that it takes under an hour a week, while incorporating decades of data and trade-research to determine reliable buy and sell signals.
If you're interested in seeing what a system like this can do for you, download this case study. There, you can read buy-and-sell dates, trade sizes, and broker reports of the large-cap stock positions opened and closed in that portfolio.