Contrary to the claims of many academics, there are some investors in this world who consistently earn high rates of return. What are the five traits of these “intelligent investors?” And what are the five things they avoid? To which category do you belong? Would an “intelligent investor” be buying gold right now?
Contrary to the claims of many academics, there are some investors in this world who consistently earn high rates of return. What are the five traits of these “intelligent investors?” And what are the five things they avoid? To which category do you belong? Would an “intelligent investor” be buying gold right now? After all, the gold price ended 2014 below the $1,200 threshold.
The maxim of many banks and asset managers is: diversify as much as you can. However, as legendary investor Warren Buffet once told: “Diversification is protection against ignorance. It makes little sense if you know what you are doing.” Moreover, diversification does not automatically limit your losses ? as we saw in 2008, when stocks dropped by 50% ? but it surely does limit your upward potential. In fact, over-diversification is a guarantee for mediocrity.
There is a second reason to avoid over-diversification. We can never know as much about hundred different investments as we can know about, say, five investments. We need to focus our knowledge and time on a limited number of investment opportunities. It is naïve to assume that it would be possible for us to gain expertise on 100 different companies, commodities or international markets.
The intelligent investor tries to limit potential losses, while not limiting potential gains. This means to aim at capital preservation, instead of capital growth. An intelligent investor ensures he has a “margin of safety.” If I believe silver to be worth €600 per kilo, I intend to buy when the silver price is significantly below that estimation. This means risk-avoidance, instead of risk-seeking. Seth Klarman once wrote: “Consideration of risk must never take a backseat to return.”
Avoiding losses should be the main objective of all investors. This does not mean we should avoid all risk and all potential losses. To avoid losing money means to avoid suffering a significant loss of principal over a period of several years.
Closely related is the idea to compare rates of return. Many investment funds believe to have performed well when they lose 40% of their capital, while market indices were down 50%. Obviously, this is ridiculous. The intelligent investor instead aims at achieving a positive real rate of return every year, regardless of others.
Moreover, when the sky seems to be the limit for stock prices, intelligent investors may underperform market indices. There is nothing wrong with that. The intelligent investor aims at capital preservation; capital growth is something that results from aiming at capital preservation and buying securities at large margins of safety.
Successful investors are patient investors. They allow opportunities to pass by and wait quietly until they are fully convinced of a certain opportunity. After all, you don’t have to take advantage of every single opportunity to achieve a high rate of return.
The intelligent investor is therefore like a batter who does not try to hit every single pitch. He does not have to seize every single opportunity, but waits patiently for one he can confidently pursue. Moreover, this gives him a solid foundation in case the price initially falls.
Of course, this requires strong emotional capabilities. Regret is common. Who does not remember deciding not to buy a certain security only to see its price subsequently rising?
When market indices are falling, many investors start to panic. However, some are blessed with a certain gen that inhibits hasty decisions. They naturally stay calm when the value of their investments is dropping steadily. Others, the majority of us, will have more difficulties in such a scenario. They have to do something that is contrary to human nature: going against the crowd.
In the market, however, money can be earned by disagreeing with the other market participants. The only reason we make money ? by buying low and selling high ? is that at some point the market reflects our opinion on the value of an investment. If we can honestly say to ourselves that we made a certain investment for valid reasons, circumstances unchanged, we equally need to have the courage to increase our positions when the price initially drops instead of selling our positions due to panic.
Everybody wants to be the perfect market timer, but you have to be prepared to accept initial paper losses.
Remember the 2001 speculative dot-com bubble? Many investors don't, because in 2014 once again many technology stocks reached bizarre heights.
The future will undoubtedly have new investment frenzies in store for us. However unavoidable that may be, it will equally be unavoidable that there will not be any alarm bells ringing to signal the extremes beforehand. Investors that study the technology bubble will, however, be able to recognize and anticipate new frenzies.
In a similar way, an intelligent investor will not be distracted by sudden sharp price increases. When the silver price increased by over 50% over the course of a few months in 2011, it was time to sell silver instead of buying.
Do you have these five traits that characterize smart and successful investors? If so, which trait do you need to develop most? Which trait do you find difficult? How can you relate these traits to your investment portfolio?
The fundamental reasons to invest in gold remain unaltered. World-wide indebtedness has, once more, increased in 2014 to even more shocking levels. Central banks world-wide are resorting to cheap-money policies. Moreover, China’s gold demand is huge and central banks are net buyers of gold. Many other events are on the verge of happening (for instance, we are patiently waiting for a resurge of the euro crisis, see Greece).
An intelligent investor would undoubtedly consider buying gold right now. The drop in the price of gold means a larger “margin of safety” (lower price relative to the intrinsic value) and thus a less risky investment.
1) Investing while only paying attention to prices and not to values, or only to values and not to prices. It is always the price/value ratio that matters.
2) Believing too much in the quantitative forecasts of economists, “experts,” statesmen and government agencies. A well-known joke about the Dutch Agency for Statistics (CBS) is that they structurally overestimate changes in the GDP in times of economic downturn and consistently underestimate them in times of economic growth. That is, the CBS is very good at drawing a straight line.
3) Losing sleep over daily price fluctuations.
4) Believing that governments can keep short-term and long-term interest rates low indefinitely.
5) Focusing on the short-term. Nothing is more important to the success of an investor.
I maintain that smart investors are buying gold right now.
Disclaimer: The author is long gold, short Twitter and Netflix. The information contained in this article does not constitute an offer, investment advice or financial service.