In life, things
rarely work out the way you'd expect. The "nice guy" hardly ever gets
the girl. The smartest kid in the class never becomes rich and famous.
Meanwhile, the problematic student with lousy grades in high school ends
up in the U.S. Senate -- or beyond.
The investment world also
has its share of "crazy" rules. I call them "crazy" because they
highlight the way the investing world works in ways you would never
expect.
Yet understanding these "crazy" rules, and how you can
apply them, can spell the difference between making (and keeping) your
investment profits -- or, at worst, spending an unpleasant stint in the
poor house.
With that backdrop, here are my three "crazy" rules...
1. Don't Confuse Luck with Smarts
Old
time traders put this view another way: "Never confuse brains with a
bull market." The role of "luck" in investment success is more
complicated than you think.
You probably believe that if you turn
a $10,000 investment in a single stock into $1 million, it would be the
best thing that could ever happen to you. But you'd be wrong.
After
enjoying such remarkable success, you'd suddenly think that you'd
"cracked the code" of the markets. The next time around, you'd have the
confidence to bet your life savings on another "can't lose" investment.
And maybe you'd win this time, as well. So you do it again.
After
all, you calculate that if you repeat your success only one more time,
you'd have $100 million in the bank. But this time, you tell yourself
that once this investment hits, you'd take all of your chips off of the
table.
Sure enough, your luck runs out and your latest "can't
lose" investment flops. And since you "bet the farm," you not only lost
your shirt but you're also deeply in debt.
You wake up one morning to realize that you are worse off than when you started.
That's
the problem with sudden wealth -- whether it comes from a big bet on a
stock tip, buying a winning lottery ticket or becoming a highly paid
pro-athlete.
Almost everyone who wins the lottery ends up poorer
five years later than beforehand. You see formerly wealthy pro athletes
declaring bankruptcy almost every week.
The lesson? Understand that if you have ever won a big investment bet, you were at least as lucky as you were smart.
Over the long term, there are no shortcuts. Making money on a consistent basis is a grind that is one part "insight" and nine parts "discipline".
2. Your Analysis Is Irrelevant to Your Investment Success
The philosopher Friedrich Nietzsche once observed that, "Any explanation is better than none."
I disagree. Sometimes, in the investment world, no explanation is really necessary -- or relevant.
Today,
you suffer from information overload. You can access more information
about the financial markets than ever before. Yet, I bet your investment
returns have not improved.
Not only do we seem incapable of
divining the future, we can't even seem to agree on what happened. Was
the credit crunch a result of Greenspan's monetary policy? Bernanke's
incompetence? Clinton's "affirmative action" mortgages for low-income
borrowers? Or was it just a classic mania? We crave explanations because
it gives us an illusion of control.
But it gets even worse. Even
the "doom and gloomers " who got their analysis "right" in predicting
the credit crunch weren't able to turn their insights into money for
their clients. Analysts who promised to "crash-proof" their clients'
portfolios ended up losing more money for their clients than if they had
stuck with simple index funds.
That's because they weren't that
right after all. Gold didn't hit $3,000 an ounce. The U.S. dollar didn't
implode. Treasuries didn't collapse. And the U.S. stock market
recovered.
The lesson? Successful investors are successful in the long term because they admit their mistakes.
As the world's greatest speculator George Soros said, "My system doesn't work by making valid predictions. It works by allowing me to recognize when I am wrong."
3. Your "Intelligence" is Your Biggest Handicap
Warren Buffett famously observed that it takes no more than average intelligence to become a successful investor.
I'd add something to that perspective. I'd say high intelligence is actually a handicap to successful investing.
Here's
why. When you are smart, you are used to being 100% correct. You just
can't accept the possibility of being wrong. So you stick to your guns,
even when the market is telling you otherwise.
That's why
overeducated Wall Street analysts make such lousy money managers and why
hedge fund managers who flaunt their intelligence inevitably flounder.
Think
about it this way. If high intelligence was the key to successful
investing, top business school professors and economists would be the
wealthiest guys on the planet. Instead, the Forbes 400 is populated by
dropouts from places like Harvard (Bill Gates) and Stanford (the Google
guys).
That's also why poker players make the best traders and
investors. They play each hand as if it is dealt to them. If they get a
bad hand, they fold. They play the investment game the same way.
Perhaps that's also why a former Dean of Harvard College, Henry Rosovsky, observed the following about Harvard students, "Our A students become professors. Our B students go to law school. Our C students rule the world."
Now you also understand why my Harvard law school classmate Barack Obama doesn't release his college and law school transcripts.
How You Can Apply These Three Crazy Rules
So, how can you use these "crazy" rules to improve your investment returns?
First,
never bet too big on one idea. You may get lucky once. Maybe even
twice. But your luck will eventually run out. And if you bet the farm,
you are out of the investment game for good.
Second, don't delude
yourself into thinking that you have special insight into the market.
Bring that attitude to your investments, and you will have your head
handed to you.
And it's not a question of "if" but "when".
Third,
learn to think of your investments like a hand in a poker game. Up the
ante when you are lucky enough to get a good hand. But also be prepared
to fold -- and to fold often.
By following these rules, I have saved me from my own follies more than once.
They will do the same for you.
By Nicholas A. Vardy
Editor, The Global Guru
http://www.nicholasvardy.com
(http://sharemarket-srilanka.blogspot.co.uk/)
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