Losers have goals. Winners have systems.
In my teenage years, I seemed to always forget bringing something important when leaving the house. Whenever my father noticed, he would badger me. “You need a system!” was a recurring piece of advice. Clearly, I didn’t have a check for remembering my keys or wallet, and at least 10 years would pass before I became smarter about it. I learned the hard way. Although I believe my father was really referring to the importance of having a checklist, there is a relationship between the two. When it comes to stock picking, most of us engage in it without a real investment system that ties every decision to our long term objectives.
It would be reasonable to assume that if the traffic system in any large city were to be removed overnight, the accident rate would skyrocket. Left to our senses and second-to-second reactions, we do not stand much of a chance to organize ourselves en masse. The same goes for public education. Without a system, some students may be better off if teachers were left completely to their own innovations, but I think we can agree that society would be worse off if there weren’t any consistency in the education curriculum.
Choosing Process Over Pinpoint Goals
In the world of baseball, Billy Beane has a system for identifying undervalued athletes. He is thus able to consistently squeeze much out of a limited annual budget. In another baseball example, Ted Williams developed a system that resulted in the highest on-base percentage of all time. By dividing the strike zone into seventy-seven cells, and swinging only at the cells with the highest probabilities of success, Williams secured his place in history.
Scott Adams has written about the importance of focusing on systems rather than setting specific goals. Success favors those who focus on getting their roadmap correct. Fixating on pinpoint goals, such as achieving a minimum 15% total return in every year, could lead to overly-aggressive behavior or decisions incongruent with one’s investment philosophy. However, upping the odds of long term success by identifying well-run, sound businesses – and then buying them only when favorably priced – is a system. Actually, I would say that sums up what Starvine’s and most value investors’ approaches aim to achieve.
Methodical = Replicable
The majority of market participants trade without a system; this is especially true for retail investors. But why is this important to acknowledge? Well, if one of your objectives is to compound money over the long term (say 10+ years), the following applies to you. Picture your portfolio in 20 years: it is much larger than you expected solely because of shrewd stock picking. Wonderful. Now I present a few rhetorical questions. Would you have preferred the outcome to be the result of a successive string of one-off, large bets? Or would you go for the methodical path that is more measured and hence more replicable in nature? Which one would truly serve your interests better? Long term consistency is the holy grail of compounding. In order to achieve the investment success we desire over decades, it stands to reason that a system must be employed. And a system is carried out with a set of rules. The following are examples of considerations to reflect on before establishing your own rules:
Guardrails: We All Need Them
If we could identify a 100-bagger (i.e. a stock whose price goes up 100x) with complete certainty, there would be only one stock in the account and therefore no need for a portfolio management system. Life would be bliss and happiness. However, that’s not how reality plays out for 99.9% of us, and hence the need to employ guardrails to protect us from ourselves. The above are questions to help investors think about topics on which basic guidelines in managing your portfolio can be set.
Notice how I refrain from suggesting numbers to use in your rules. That is because no one size ever fits all. Also, my intention is to encourage people to realize the importance of having a system (whatever the investment philosophy), rather than promote how to execute the strategy.
Sound Logic Leads to Consistency
Over time, your system should evolve. If you are a buy and hold, long only value investor, short term randomness cannot be eliminated, as far as fluctuations in portfolio value are concerned. Perhaps it also can be posited that mistakes can never be completely quashed. However, a framework based on sound logic will aid in keeping your decisions grounded. For example, if your valuation of a shiny new investment idea shows that it is priced approximately at intrinsic value, how could it make sense to source the funds from selling an existing holding that is trading at 50% of intrinsic value? Maybe there is a way it can make perfect sense given the subjective nature of valuation. The point here is that an investor with an objective ranking method stands a better chance of making rational decisions versus one that goes totally off instinct.
Ultimately, rules mean trade-offs and compromise. By being systematic in our investing, we are instilling discipline and order into decisions. Continually questioning the rules we set for ourselves will also encourage us to be thoughtful about what level of diversification optimizes the gain from research efforts versus protecting from the downside of human error.
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