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10 Legendary Investment Rules From Legendary Investors

  • Written by Syndicated Publisher No Comments Comments
    December 14, 2014

    I live in Houston, which has been a huge economic beneficiary of the sustained increases in oil prices, drilling, refining and related processes. As such, the amount of wealth created in energy-related investments has been enormous and, not surprisingly, a vast majority of individuals have overweighted portfolios in energy with the expectations that “oil prices can only go up.”  Of course, this sentiment is certainly understandable when you look at the performance of the energy sector versus the S&P 500 since the turn of the century. (Annualized return, capital appreciation only: S&P 500 3.24% vs Energy 17.71%)

    SP500-Energy-Perf-121014

    Not surprisingly, the recent plunge in oil prices, and related energy stocks, has sent investors scurrying for cover. Previous “complacency” has turned to outright “panic” as portfolios, and retirement plans, have been crushed by plunging asset prices.

    Strongly rising asset prices, and in this case commodity prices, have driven investor exuberance in the sector leading many to ignore deteriorating fundamentals, excessive leverage, and other financial diseases. However, when prices deteriorate rapidly, investment mistakes are quickly revealed.

    It is important to remember that we are not investors. We are speculators placing bets on the direction of the price of an electronic share. More importantly, we are speculating, more commonly known as gambling, with our “savings.” We are told by Wall Street that we “must” invest into the financial markets to keep those hard-earned savings adjusted for inflation over time. Unfortunately, due to repeated investment mistakes, the average individual has failed in achieving this goal.

    With this in mind, this is an excellent time to review 10 legendary investment lessons from legendary investors. These time-tested rules about “risk” are what have repeatedly separated successful investors from everyone else. (Quote Source: 25iQ)


    1) Jeffrey Gundlach, DoubleLine

    “The trick is to take risks and be paid for taking those risks, but to take a diversified basket of risks in a portfolio.”

    This is a common theme that you will see throughout this post. Great investors focus on “risk management” because “risk” is not a function of how much money you will make, but how much you will lose when you are wrong. In investing, or gambling, you can only play as long as you have capital. If you lose too much capital but taking on excessive risk, you can no longer play the game.

    Be greedy when others are fearful and fearful when others are greedy. One of the best times to invest is when uncertainty is the greatest and fear is the highest.

    2) Ray Dalio, Bridgewater Associates

    “The biggest mistake investors make is to believe that what happened in the recent past is likely to persist. They assume that something that was a good investment in the recent past is still a good investment. Typically, high past returns simply imply that an asset has become more expensive and is a poorer, not better, investment.”

    Nothing good or bad goes on forever. The mistake that investors repeatedly make is thining “this time is different.” The reality is that despite Central Bank interventions, or other artificial inputs, business and economic cycles cannot be repealed. Ultimately, what goes up, must and will come down.

    WallStreet wants you to be fully invested “all the time” because that is how they generate fees. However, as an investor, it is crucially important to remember that “price is what you pay and value is what you get.” Eventually, great companies will trade at an attractive price. Until then, wait.

    3) Seth Klarman, Baupost

    “Most investors are primarily oriented toward return, how much they can make and pay little attention to risk, how much they can lose.”

    Investor behavior, driven by cognitive biases, is the biggest risk in investing. “Greed and fear” dominate the investment cycle of investors which leads ultimately to “buying high and selling low.”

    Investor-Psychology-Cycle-082814

    4) Jeremy Grantham, GMO

    “You don’t get rewarded for taking risk; you get rewarded for buying cheap assets. And if the assets you bought got pushed up in price simply because they were risky, then you are not going to be rewarded for taking a risk; you are going to be punished for it.

    Successful investors avoid “risk” at all costs, even it means underperforming in the short-term. The reason is that while the media and WallStreet have you focused on chasing market returns in the short-term, ultimately the excess “risk” built into your portfolio will lead to extremely poor long-term returns. Like Wyle E. Coyote, chasing financial markets higher will eventually lead you over the edge of the cliff.

    5) Jesse Livermore, Speculator

    “The speculator’s deadly enemies are: ignorance, greed, fear and hope. All the statute books in the world and all the rule books on all the Exchanges of the earth cannot eliminate these from the human animal….”

    Allowing emotions to rule your investment strategy is, and always has been, a recipe for disaster. All great investors follow a strict diet of discipline, strategy, and risk management.

    6) Howard Marks, Oaktree Capital Management

    “Rule No. 1:  Most things will prove to be cyclical. – Rule No. 2:  Some of the greatest opportunities for gain and loss come when other people forget Rule No. 1.”

    As with Ray Dalio, the realization that nothing lasts forever is critically important to long term investing. In order to “buy low,” one must have first “sold high.” Understanding that all things are cyclical suggests that after long price increases, investments become more prone to declines than further advances.

    7) James Montier, GMO

    “There is a simple, although not easy alternative [to forecasting]… Buy when an asset is cheap, and sell when an asset gets expensive…. Valuation is the primary determinant of long-term returns, and the closest thing we have to a law of gravity in finance.”

    “Cheap” is when an asset is selling for less than its intrinsic value. “Cheap” is not a low price per share. Most of the time when a stock has a very low price, it is priced there for a reason. However, a very high priced stock CAN be cheap. Price per share is only part of the valuation determination, not the measure of value itself.

    8) George Soros, Soros Capital Management

    “It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.

    Back to risk management, being right and making money is great when markets are rising. However, rising markets tend to mask investment risk that is quickly revealed during market declines. If you fail to manage the risk in your portfolio, and give up all of your previous gains and then some, then you lose the investment game.

    9) Jason Zweig, Wall Street Journal

    “Regression to the mean is the most powerful law in financial physics:Periods of above-average performance are inevitably followed by below-average returns, and bad times inevitably set the stage for surprisingly good performance.

    The chart below is the 3-year average of annual inflation-adjusted returns of the S&P 500 going back to 1900. The power of regression is clearly seen. Historically, when returns have exceeded 10% it was not long before returns fell to 10% below the long-term mean which devasted much of investor’s capital.

    Reversion-To-The-Mean-121014

    10) Howard Marks, Oaktree Capital Management

    The biggest investing errors come not from factors that are informational or analytical, but from those that are psychological.” 

    The biggest driver of long-term investment returns is the minimization of psychological investment mistakes. As Baron Rothschild once stated: “Buy when there is blood in the streets.” This simply means that when investors are “panic selling,” you want to be the one that they are selling to at deeply discounted prices. The opposite is also true. As Howard Marks opined: “The absolute best buying opportunities come when asset holders are forced to sell.”


    As an investor, it is simply your job to step away from your “emotions” for a moment and look objectively at the market around you. Is it currently dominated by “greed” or“fear?”  Your long-term returns will depend greatly not only on how you answer that question, but to manage the inherent risk.

     “The investor’s chief problem – and even his worst enemy – is likely to be himself.” – Benjamin Graham

    Images: Flickr (licence attribution)

    About The Author

    Lance Roberts – Host of StreetTalk Live

    After having been in the investing world for more than 25 years from private banking and investment management to private and venture capital; Lance has pretty much “been there and done that” at one point or another. His common sense approach has appealed to audiences for over a decade and continues to grow each and every week.

    Lance is also the Chief Editor of the X-Report, a weekly subscriber based-newsletter that is distributed nationwide. The newsletter covers economic, political and market topics as they relate to the management portfolios. A daily financial blog, audio and video’s also keep members informed of the day’s events and how it impacts your money.

    Lance’s investment strategies and knowledge have been featured on Fox 26, CNBC, Fox Business News and Fox News. He has been quoted by a litany of publications from the Wall Street Journal, Reuters, The Washington Post all the way to TheStreet.com as well as on several of the nation’s biggest financial blogs such as the Pragmatic Capitalist, Zero Hedge and Seeking Alpha.
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