The Mindset of an Investor
“No matter how great the talent or effort, some things just take time: you can’t produce a baby in one month by getting nine women pregnant.”
Warren Buffett
‘The investor’s chief problem—and even his worst enemy—is likely to be himself,’ says Warren Buffett. Investment is as much about psychology as it is about economics. People often fail in the former. World-class economists don’t make world-class investors. Many of them are the worst performers. Investment success depends on the mental make-up of the investor combined with technical competence.
Few know Albert Einstein invested much of his 1921 Nobel Prize money in stock markets. However, he lost bulk in the stock market crash in 1929. Einstein was awarded 121,572.54 in Swedish kronor for his Nobel Prize in Physics, which was equivalent to over twelve years’ income for Albert Einstein back then. He lost almost all of it and realised that his Nobel Prize-winning wisdom was not suitable for winning in the stock market. The stock market requires a different temperament. (Later, Einstein remarked that the power of compound interest is the most powerful force on earth.)
You are your worst enemy. Frenzy, exuberance and excesses in the market, dubious companies with window-dressed balance sheets, a sudden change in domestic and international macros may not harm you as much as your own temperament.
Patience
The most important trait that an investor ought to have is patience. No matter how technically sound you are, you are likely to face rough weather. The market will go down, your investment will under-perform for quite some time, and unless you have inculcated the virtue of patience, you are likely to sell at the wrong time. Lack of patience makes people do dumb things with their money.
Greed and fear are two dominating forces in the market, and unless you have trained your senses to stay disciplined in the face of such extreme market behaviours, you are likely to succumb. Factors that distinguish Warren Buffett, Charlie Munger and Peter Lynch from other investors are the tremendous patience and discipline they have.
Buffett says he would be happy if the stock markets closed for ten years after he bought his investments so he would have no means to track his investments while they continued to grow. It requires nothing less than Job’s patience to hold on to your investment when the market forces are against it—and a great deal of conviction in your investment philosophy.
Munger says, ‘You have to be patient, wait until something comes along, which, at the price you’re paying, is easy. That’s contrary to human nature, just to sit there all day long doing nothing, waiting. It’s easy for us, we have a lot of other things to do. But for an ordinary person, can you imagine just sitting for five years doing nothing? You don’t feel active, you don’t feel useful, so you do something stupid.’ We are not out in the market, looking for investments; we are just waiting for the right investments which we have identified as having become available to us at the right price. Till the price comes to the level that gives enough margin of safety, we wait, with our ears and eyes wide open. We keep reading everything about the potential investment. The day the right investment becomes available to us at the price we wanted to buy it, we buy like crazy.
Investing Is Not Cricket
In cricket, the batsman must hit every ball that is bowled to him. If he does not, either the ball hits the stumps, or if he obstructs the stumps with his body, it will be an LBW. He has to decide at every ball how to play so he remains at the crease for a longer time and can score well when he can hit the sweet spot. The player remains under tremendous pressure, the cheering and shouting of spectators adding to the confusion.
The intelligent investor does not invest like the intelligent cricketer plays cricket. He has an advantage over the cricketer. He need not play every ball. He can decide not to play a ball he does not understand, and it has no penalty point. He can wait for a favourable ball to come, and he can hit that ball with full force.
Warren Buffett used the baseball analogy to explain this point. He says, ‘The trick in investing is just to sit there and watch pitch after pitch go by and wait for the one right in your sweet spot. And if people are yelling “Swing, you bum!” ignore them.’ Buffett only invests in companies that are within his ‘circle of competence,” a concept he first described in his 1996 shareholder letter. ‘You don’t have to be an expert on every company or even many,’ he says. ‘You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.’
If you stick to what you know, you would never go wrong. You don’t have to buy every stock that looks interesting to you. You should have the ability to filter out the noise and focus on the companies you can understand. Because of your education, experience, interest, research, and passion, you might have developed expertise in certain industries. Sticking to those industries would make your investment safe. You may ignore the Infosyses and Wipros if you do not understand the technology. They may be great investment ideas, but they are not for you.
Buffet says the size of your circle of competence is also not very important. Even a narrow circle is big enough to filter out the required portfolio size for you. However, an intelligent investor is a lifetime student. He keeps widening his circle of competence.
When students asked Buffett’s advice on how to get rich, he would say, ‘I could improve your ultimate financial welfare by giving you a ticket with only twenty slots in it so that you had twenty punches—representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all.’
If you decide that you have to hit only 20 balls during your entire investing career and there is no penalty for not playing a ball, you will be as careful as you can. You will buy only those companies you can understand well; else you will not hold it for a day.
If you look at the Indian market scene, it is opposite to this. People are burning off their energies and monies buying and selling stocks they don’t understand at the drop of a hat. They perhaps bought them on tips and would sell them when they need money for buying another tip. At the end of the year, when they draw the accounts for the year, they find that while they have been moving at a frantic pace, they’ve travelled no distance. They end up making more money for intermediaries through commission than for themselves. We need a disciplined, systematised approach towards stock market investing.
The market is dominated by untrained traders who do not know how to control their emotions. Alternating bouts of greed and fear decide a trader’s investment patterns. When buying a mobile phone, he carries out a vast amount of research about the megapixels of the camera and the GB in the RAM and battery life. When investing, he leaves it on Mr Market to decide for him. If he were to spend half as time on his lakhs of rupees worth of investment as he spends on buying a ₹20,000 mobile phone, he would be much better off. He fails to see the stock as a share in the business and looks at it as a money-making proposition. I hope every investor reads this book to train his mind in the right way to invest.
Insulation
The investor needs to inculcate the talent to turn out the noise. Tune in to CNBC, and you’ll see tickers moving up and down, trying to capture every news and every piece of rumour. More often than not, the ‘information’ is mere noise, with no effect on the fundamentals of the stock. The recent failure of IL&FS created panic waves in the market, and all NBFC shares went tumbling down. When the market reacts, it overreacts. Shutting down noise will make you rise much above the average investor whose buy and sell decisions are impacted by short-term noises in the market. Some people don’t want to miss a single piece of chatter and stay glued to the screen all day long. In the connected world, information travels fast, and misinformation travels faster. A single WhatsApp message can bring a company down. (A recent example is Infibeam; one message caused a 70% fall in price.) And a single Tweet may make the stock soar. (A recent example is Elon Musk tweeting about Tesla getting international funding.) The reaction is often disproportionate to the financial implication of the news. (Efficient market hypothesis proponents would frown.)
Focus
The ability to stay on course in the face of conflicting signals is an important winning trait. Staying on course is a close cousin of patience, and intelligent investors are known not to deviate. The average investor digresses from the course because he doesn’t even know what path he has chosen. He does not define his investment goals. If you do not know where you want to go, you can never reach it. Hundreds of distractions coming his way every day are likely to make him sell when he should buy and vice versa.
The ability to stay calm in the face of a storm makes you a successful investor. When there is blood in the market, most people are seen running for cover. The intelligent investor stays calm and unperturbed and tries to find value in the market. During frenzy, people who stay calm are likely to discover great investments, while others seem to be feeling the heat.
Do Your Homework
The intelligent investor remains patient and calm and does not succumb to noise and stays on course because of an important trait he possesses: he does his homework well. He knows why he has made a particular investment. He studies every quarterly result, half-yearly result, and annual results of the company he has invested in to know the original premise he based his decisions on are still valid; and if it is no longer valid, does it call for a change in decision? Experience suggests that if you have done your homework well and are satisfied with the fundamentals of the company, in a majority of cases, you are likely to find a reinforcement of your belief in subsequent events.
In a few cases, you are likely to see the fundamentals deteriorate. However, if the fundamentals of one company you have invested in deteriorate beyond repair, you might consider exiting it. Selling at this point also requires a calm mind: if fundamentals have gone off the mark, the intelligent investor would exit the scrip, while the frenzy investor would wait for the share to come back to a particular price so he recovers his losses, which may prove to be a futile exercise.
The intelligent investor rarely sells his investment unless he needs money or unless he finds that fundamental assumptions are no longer valid. And when he sells it, he remains indifferent to the profit or loss made in the transaction. To him, the latter situation is nothing more than plucking out the weeds so that the rest of the farm may grow better.
(Dr Tejinder Singh Rawal is the author of the best-selling book Loads of Money: Guide to Intelligent Stock Market Investing: Common Sense Strategies for Wealth Creation)
Warren Buffett
‘The investor’s chief problem—and even his worst enemy—is likely to be himself,’ says Warren Buffett. Investment is as much about psychology as it is about economics. People often fail in the former. World-class economists don’t make world-class investors. Many of them are the worst performers. Investment success depends on the mental make-up of the investor combined with technical competence.
Few know Albert Einstein invested much of his 1921 Nobel Prize money in stock markets. However, he lost bulk in the stock market crash in 1929. Einstein was awarded 121,572.54 in Swedish kronor for his Nobel Prize in Physics, which was equivalent to over twelve years’ income for Albert Einstein back then. He lost almost all of it and realised that his Nobel Prize-winning wisdom was not suitable for winning in the stock market. The stock market requires a different temperament. (Later, Einstein remarked that the power of compound interest is the most powerful force on earth.)
You are your worst enemy. Frenzy, exuberance and excesses in the market, dubious companies with window-dressed balance sheets, a sudden change in domestic and international macros may not harm you as much as your own temperament.
Patience
The most important trait that an investor ought to have is patience. No matter how technically sound you are, you are likely to face rough weather. The market will go down, your investment will under-perform for quite some time, and unless you have inculcated the virtue of patience, you are likely to sell at the wrong time. Lack of patience makes people do dumb things with their money.
Greed and fear are two dominating forces in the market, and unless you have trained your senses to stay disciplined in the face of such extreme market behaviours, you are likely to succumb. Factors that distinguish Warren Buffett, Charlie Munger and Peter Lynch from other investors are the tremendous patience and discipline they have.
Buffett says he would be happy if the stock markets closed for ten years after he bought his investments so he would have no means to track his investments while they continued to grow. It requires nothing less than Job’s patience to hold on to your investment when the market forces are against it—and a great deal of conviction in your investment philosophy.
Munger says, ‘You have to be patient, wait until something comes along, which, at the price you’re paying, is easy. That’s contrary to human nature, just to sit there all day long doing nothing, waiting. It’s easy for us, we have a lot of other things to do. But for an ordinary person, can you imagine just sitting for five years doing nothing? You don’t feel active, you don’t feel useful, so you do something stupid.’ We are not out in the market, looking for investments; we are just waiting for the right investments which we have identified as having become available to us at the right price. Till the price comes to the level that gives enough margin of safety, we wait, with our ears and eyes wide open. We keep reading everything about the potential investment. The day the right investment becomes available to us at the price we wanted to buy it, we buy like crazy.
Investing Is Not Cricket
In cricket, the batsman must hit every ball that is bowled to him. If he does not, either the ball hits the stumps, or if he obstructs the stumps with his body, it will be an LBW. He has to decide at every ball how to play so he remains at the crease for a longer time and can score well when he can hit the sweet spot. The player remains under tremendous pressure, the cheering and shouting of spectators adding to the confusion.
The intelligent investor does not invest like the intelligent cricketer plays cricket. He has an advantage over the cricketer. He need not play every ball. He can decide not to play a ball he does not understand, and it has no penalty point. He can wait for a favourable ball to come, and he can hit that ball with full force.
Warren Buffett used the baseball analogy to explain this point. He says, ‘The trick in investing is just to sit there and watch pitch after pitch go by and wait for the one right in your sweet spot. And if people are yelling “Swing, you bum!” ignore them.’ Buffett only invests in companies that are within his ‘circle of competence,” a concept he first described in his 1996 shareholder letter. ‘You don’t have to be an expert on every company or even many,’ he says. ‘You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.’
If you stick to what you know, you would never go wrong. You don’t have to buy every stock that looks interesting to you. You should have the ability to filter out the noise and focus on the companies you can understand. Because of your education, experience, interest, research, and passion, you might have developed expertise in certain industries. Sticking to those industries would make your investment safe. You may ignore the Infosyses and Wipros if you do not understand the technology. They may be great investment ideas, but they are not for you.
Buffet says the size of your circle of competence is also not very important. Even a narrow circle is big enough to filter out the required portfolio size for you. However, an intelligent investor is a lifetime student. He keeps widening his circle of competence.
When students asked Buffett’s advice on how to get rich, he would say, ‘I could improve your ultimate financial welfare by giving you a ticket with only twenty slots in it so that you had twenty punches—representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all.’
If you decide that you have to hit only 20 balls during your entire investing career and there is no penalty for not playing a ball, you will be as careful as you can. You will buy only those companies you can understand well; else you will not hold it for a day.
If you look at the Indian market scene, it is opposite to this. People are burning off their energies and monies buying and selling stocks they don’t understand at the drop of a hat. They perhaps bought them on tips and would sell them when they need money for buying another tip. At the end of the year, when they draw the accounts for the year, they find that while they have been moving at a frantic pace, they’ve travelled no distance. They end up making more money for intermediaries through commission than for themselves. We need a disciplined, systematised approach towards stock market investing.
The market is dominated by untrained traders who do not know how to control their emotions. Alternating bouts of greed and fear decide a trader’s investment patterns. When buying a mobile phone, he carries out a vast amount of research about the megapixels of the camera and the GB in the RAM and battery life. When investing, he leaves it on Mr Market to decide for him. If he were to spend half as time on his lakhs of rupees worth of investment as he spends on buying a ₹20,000 mobile phone, he would be much better off. He fails to see the stock as a share in the business and looks at it as a money-making proposition. I hope every investor reads this book to train his mind in the right way to invest.
Insulation
The investor needs to inculcate the talent to turn out the noise. Tune in to CNBC, and you’ll see tickers moving up and down, trying to capture every news and every piece of rumour. More often than not, the ‘information’ is mere noise, with no effect on the fundamentals of the stock. The recent failure of IL&FS created panic waves in the market, and all NBFC shares went tumbling down. When the market reacts, it overreacts. Shutting down noise will make you rise much above the average investor whose buy and sell decisions are impacted by short-term noises in the market. Some people don’t want to miss a single piece of chatter and stay glued to the screen all day long. In the connected world, information travels fast, and misinformation travels faster. A single WhatsApp message can bring a company down. (A recent example is Infibeam; one message caused a 70% fall in price.) And a single Tweet may make the stock soar. (A recent example is Elon Musk tweeting about Tesla getting international funding.) The reaction is often disproportionate to the financial implication of the news. (Efficient market hypothesis proponents would frown.)
Focus
The ability to stay on course in the face of conflicting signals is an important winning trait. Staying on course is a close cousin of patience, and intelligent investors are known not to deviate. The average investor digresses from the course because he doesn’t even know what path he has chosen. He does not define his investment goals. If you do not know where you want to go, you can never reach it. Hundreds of distractions coming his way every day are likely to make him sell when he should buy and vice versa.
The ability to stay calm in the face of a storm makes you a successful investor. When there is blood in the market, most people are seen running for cover. The intelligent investor stays calm and unperturbed and tries to find value in the market. During frenzy, people who stay calm are likely to discover great investments, while others seem to be feeling the heat.
Do Your Homework
The intelligent investor remains patient and calm and does not succumb to noise and stays on course because of an important trait he possesses: he does his homework well. He knows why he has made a particular investment. He studies every quarterly result, half-yearly result, and annual results of the company he has invested in to know the original premise he based his decisions on are still valid; and if it is no longer valid, does it call for a change in decision? Experience suggests that if you have done your homework well and are satisfied with the fundamentals of the company, in a majority of cases, you are likely to find a reinforcement of your belief in subsequent events.
In a few cases, you are likely to see the fundamentals deteriorate. However, if the fundamentals of one company you have invested in deteriorate beyond repair, you might consider exiting it. Selling at this point also requires a calm mind: if fundamentals have gone off the mark, the intelligent investor would exit the scrip, while the frenzy investor would wait for the share to come back to a particular price so he recovers his losses, which may prove to be a futile exercise.
The intelligent investor rarely sells his investment unless he needs money or unless he finds that fundamental assumptions are no longer valid. And when he sells it, he remains indifferent to the profit or loss made in the transaction. To him, the latter situation is nothing more than plucking out the weeds so that the rest of the farm may grow better.
(Dr Tejinder Singh Rawal is the author of the best-selling book Loads of Money: Guide to Intelligent Stock Market Investing: Common Sense Strategies for Wealth Creation)
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