The traits of successful investors; How to gain an 'edge'

In yesterday's e-mail, I said that the two basic things I look for in any investor are the right skills and the right approach. And for each, there are eight traits I look for...

Today, I'll spell out what these traits are, and then discuss the (coincidentally) eight ways in which investors can gain an edge.

When it comes to the right skills, most successful investors have the following characteristics:

1) They are businesspeople, and they understand how industries work and companies compete. As the legendary Warren Buffett once said:

I am a better investor because I am a businessman, and a better businessman because I am an investor.

2) They have a lot of intellectual horsepower. However, above a certain level, smarts don't matter. To quote Buffett again:

Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ.

3) They are good with numbers (though advanced math is irrelevant) and are able to seize on the most important nuggets of information in a sea of data. Over the past 20 years, the challenge for investors has inverted from finding information to processing the deluge of it.

4) They are simultaneously confident and humble – and they learn from their mistakes. A high degree of confidence comes easily to most people in the business... it's the latter that presents the problem. Buffett is a great role model.

5) They are independent, and neither take comfort in standing with the crowd nor derive pride from standing alone. I would guess that 90% of people fit into the former category, with the remainder being ornery contrarians. The key to investment success is being neither.

6) They are patient. To repeat what I've said many times: Trying to get rich quickly is the surest way to get poor quickly.

As legendary investor John Templeton noted:

If you find shares that are low in price, they don't suddenly go up. Our average holding period is five years.

Additionally, Buffett often talks about the importance of being "long-term greedy."

7) They make decisions based on analysis, not emotion. I've written dozens of times about the many mental mistakes, rooted in emotional traps, that every investor makes – it's a subject called "behavioral finance." In December, I summarized the most important ones: Avoid these 26 'behavioral finance' traps.

8) They love what they do. The best investors keep playing the game, even after they've made more money than they know what to do with. Buffett once said, "I'm the luckiest guy in the world in terms of what I do for a living" and "I wouldn't trade my job for any job" and "I feel like tap dancing all the time."

Turning to the right approach, here are the eight characteristics I see in the most successful investors:

1) They think about investing as the purchasing of companies rather than the trading of stocks. They invest with a long-term perspective and, as I discussed in my June 20 e-mail, they let their winners run.

2) They ignore the market, other than to take advantage of its occasional mistakes. In one of the most famous quotes about investing, the father of value investing, Ben Graham, wrote in The Intelligent Investor:

Basically, price fluctuations have only one significant meaning for the true investor. They provide him an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal.

At other times, he will do better if he forgets about the stock market.

3) They only buy a stock when it's on sale. To quote Graham again, "To distill the secret of sound investment into three words, we venture the motto, margin of safety."

4) They focus first on avoiding losses and only then think about potential gains. As Buffett once said:

We look for businesses that in general aren't going to be susceptible to very much change. It means we miss a lot of very big winners but it also means we have very few big losers... We're perfectly willing to trade away a big payoff for a certain payoff.

5) They invest only when the odds are highly favorable and then invest heavily. This requires a great deal of patience and results in something akin to the "10 for 10" portfolio I discussed recently in my June 20, June 21, and June 25 e-mails: "Buying only 10 stocks and having an average holding period of 10 years."

6) They don't focus on predicting macroeconomic factors. As investing legend Peter Lynch said:

I spend about 15 minutes a year on economic analysis. The way you lose money in the stock market is to start off with an economic picture. I also spend 15 minutes a year on where the stock market is going.

7) They're flexible. They cast a wide net across various industries and types of stocks (e.g., large-cap growth, mid-cap value) to find the best opportunities while being careful to stay within their "circle of competence."

8) They shun consensus decision making. While they welcome a wide range of viewpoints, at the end of the day, they are comfortable making final decisions and living with them. While Buffett is famous for his humility, he marries it perfectly with confidence, noting that "my idea of a group decision is looking in a mirror."

To summarize, I would argue that most people, if they set their minds to it, can develop the skills I've outlined above – and anyone can follow the right approach if they have the good sense and discipline to do so.

At that point, the key to investment success is to gain an edge – one or more things that can allow you to consistently outperform all of the other smart people (and supercomputers) in the market. I've come up with eight ways in which investors might gain an edge...

1) Size. Individual investors can invest in the nooks and crannies of the market, in which there are more inefficiencies. In 1999, Buffett told Bloomberg Businessweek:

It's a huge structural advantage not to have a lot of money...

Anyone who says that size does not hurt investment performance is selling. The highest rates of return I've ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.

2) Time frame. Most investors are focused on (and, for professionals, evaluated on) short-term performance... So if you can extend your time horizon, it can be a huge advantage.

Bill Miller, who famously beat the market for a record 15 years in a row from 1991 to 2005, calls it "time arbitrage":

Time arbitrage just means exploiting the fact that most investors institutional, individual, mutual funds or hedge funds tend to have very short-term time horizons, have rapid turnover or are trying to exploit very short term anomalies in the market.

So the market looks extremely efficient in the short run. In an environment with massive short term data overload and with people concerned about minute-to-minute performance, the inefficiencies are likely to be looking out beyond, say, 12 months.

3) Concentration. Most investors hold dozens – if not hundreds – of stocks, thereby diluting their handful of best ideas with many more inferior ones.

If you want to outperform the market, consider focusing your portfolio on 10 to, at most, 20 of your highest-conviction ideas. But be careful: This works great if you know what you're doing... but will sink you if you don't.

4) Analytical. Some investors take the same information as everyone else and analyze it better – they're just unusually smart. (I think this edge is becoming more and more rare, with so many high-IQ people and sophisticated supercomputers – using AI – in the markets.)

5) Informational. While difficult, it's possible to occasionally gather information that can lead to outsized returns. I recently gave two examples of things I once did – calling dozens of Hardee's restaurants to inform my investment in CKE Restaurants and speaking with a McDonald's (MCD) franchisee in 2003 and learning of the turnaround underway at the company.

6) Relationships. Some successful investors are real loners, but I've found that most have cultivated relationships that fall into two general categories: other smart investors that they share ideas with, and industry- or company-specific relationships.

Regarding the former, some of the most profitable ideas in my career have come from other investors – for example, making more than 17 times my money in less than a year after seeing Bill Ackman's presentation in early 2009 making the case for then-bankrupt shopping mall owner General Growth Properties.

Regarding the latter, I told the story in my June 7 and June 10 e-mails about how I leveraged my relationship with Netflix co-founder Reed Hastings in 2011 to understand the potential of the company's then-nascent streaming service.

7) Experience. Investing is very much an experienced-based business, so those with more of it are likely to make better decisions.

Note that experience isn't simply a function of the number of years you've been investing. Other important factors include how steep of a learning curve you're on, whether you have good mentors, do you learn from your mistakes, and whether you're good at gaining experience the easy way – by observing others – rather than the hard way – making mistakes yourself.

8) Emotional. As I discussed earlier, one of the keys to long-term investment success is identifying and avoiding the "behavioral finance" traps that ensnare so many people.

Yes, that's a lot to think about. But if investing were easy, everyone would be successful at it...

You need to think hard about whether you have the right skills and right approach, and then where you can gain an edge.

Best regards,

Whitney

P.S. At the end of my June 3 and June 8 e-mails, I shared a few photos of my family trip in southern Italy that we scheduled around the recent Value Investing Seminar.

After the seminar finished, my daughters went home while my wife Susan and I flew to the Azores – a chain of islands that are part of Portugal – located nearly 1,000 miles off its coast.

While we mostly prefer traveling and exploring alone, we've become big fans of a company called Backroads, which organizes six-day trips all over the world for groups of one-to-two dozen Americans.

These are aimed at active travelers – couples, solos, and families – and are perhaps best known for biking-only trips in Europe. But Susan and I prefer "multi-adventure" trips that might include three days of biking, two of hiking, and a few half-day trips such as river rafting, sea kayaking, whale watching, and a historic tour of a city.

We had heard that the Azores were beautiful and the dates of Backroads' Portugal's Azores Multi-Adventure Tour fit into the window we had on our way home from Italy, so we booked it – our 10th with Backroads – and had another great experience.

The two trip leaders were wonderful, we enjoyed meeting and getting to know the other 11 people on the trip, and the Azores were as beautiful and interesting as advertised. Below are some pictures, and I've posted more on Facebook here:

P.P.S. I welcome your feedback – send me an e-mail by clicking here.