Investment theory is easy. Itโs the execution thatโs hard. Warren Buffet famously said, โWe need to be fearful when everyone else is greedy, and greedy when everyone else is fearfulโ1. It sounds really simple but itโs actually much harder to execute.
Periods of volatility and financial downturn present us with a great opportunity to buy good quality companies and reasonable prices but itโs difficult to put this into practice in an uncertain environment. The disconnect between what we should be doing, and what we actually do is caused by distractions or โnoiseโ.
So how can we turn down the volume, concentrate on investment fundamentals and stay focused on our longer-term objectives?
I find it useful to evaluate noise according to five key principles when it comes to investment decisions:
- Important vs unimportant:ย In any decision the key is to focus on what is important and eliminate anything that isnโt. In his book โGood to Greatโ Jim Collins found that companies that made the leap to โgreatโ looked at information in a very similar way. It was not about getting more information but rather about finding information that could not be ignored and eliminating extraneous distractions2.
Whatโs most important can of course vary from company to company but essentially the aim is to peel back the layers of often interesting but unimportant information. Think of it as creating a 90 second elevator pitch. When you begin, youโll probably ramble on for minutes, listing all the information you can think of. But on reflection much of this can be pared back until your left with the most important information, the essence of your investment theory.
- Facts vs emotions:ย Watching financial markets is like being on an emotional rollercoaster but to make good investment decisions itโs important not to get swept up in emotion and concentrate on the facts. My best days are when I am out talking to companies and getting a 360 view of their operating environment. My worst days are generally when Iโm sitting at my desk watching the market go up and down. This is when I risk being sucked in by emotion and making decisions based on sentiment rather than fact. Besides, Iโm not really learning anything by watching a screen. Itโs a much more effective use of my time to eliminate the noise, get out, speak to companies, and gather the facts.
- Long term vs short term:ย I donโt think I can remember a time when weโve been confronted by so much short-term noise. Inflation, cost of living pressure, geo-political tensions, supply chain disruptions, pandemic hangover, erratic weather – thereโs just so much going on! But how much of this will be relevant in five- or ten-yearsโ time?
An example I like to keep in the back of my mind when thinking about the long-term vs short-term concept involves tossing a coin. In the short term anything can happen. You could toss ten heads in a row. You could have a run of good luck, bad luck and anything in between. Over the long-term however, the fundamental truth exerts itself. ย If you toss the coin 10,000 times, 50% of the time it will come up heads and 50% of the time it will come up tails. As investors is important to have a longer-term view and remember the fundamentals.
- Simple vs complex:ย We all know and have probably at some point used the pros and cons concept to make a decision. Pros on one side of a line, conns on the other. But in investing, this can sometimes muddy the water.
In his book, โAntifragile: Things That Gain from Disorderโ Nassim Taleb argued that โIf you have more than one reason to do something just donโt do it. It does not mean that one reason is better than two, just that by invoking more than one reason you are trying to convince yourself to do something. Obvious decisions (robust to error) require no more than a single reason.โ3ย
I like to focus on the core reason for holding a stock. The number one reason it should be added or removed from the portfolio. Simplifying the process helps to screen out noise and keep me focused.
- Proactive vs reactive:ย Being proactive involves making thoughtful decisions in line with your investment goals rather than allowing the market to push you around. So, evaluating companies on their fundamentals and asking, is this going to be a good or better company if five yearsโ time? Itโs about making decisions in accordance with your investment thesis.
Currently itโs a very noisy market! Turning down the volume, particularly during periods of volatility or economic slowdown is critical as it helps us focus on whatโs important and make better investment decisions for the future.
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Originally published by Paul Taylor, Head of Investments, Australia, Fidelity