One of the most frustrating parts about the markets is the fact that edges tend to be ephemeral.
Strategies that worked beautifully in the past can stop working from increased competition, changing market dynamics or more informed investors.
I wrote about this idea earlier in the week using legendary investor and gambler Ed Thorp as an example.
Much of my writing here deals with the fact that markets are, for lack of a better term, hard. Understanding this fact of life is often the first step towards becoming a more successful investor. I’m not saying markets are impossible, just that they’re never going to be easy.
Yet to be a successful investor you do have to have some sort of edge — over yourself, the competition, the market, the way you look at the data, etc.
Individual strategies may come and go (and come back again and then go away again) but I believe there are certain edges that will never be arbitraged or competed away in the markets:
Slow traveling ideas. Jack Treynor wrote a piece called Long-Term Investing for the Financial Analysts Journal in 1976. In that piece he wrote:
When one talks about market efficiency, it is important to distinguish between ideas whose implications are obvious and consequently travel quickly and ideas that require reflection, judgment, and special expertise for their evaluation and consequently travel slowly.
Data and opinions about the markets are disseminated around the globe in the blink of an eye these days. Investment professionals will always compete for short-term profits through better technologies and the ability to find tiny edges. But those tiny edges can always be arbitraged away.
You can’t arbitrage long-term thinking. Slow traveling ideas can offer investors an edge because they require a longer time horizon.
Buying hand over fist during a bear market. There’s an old saying that stocks return to their rightful owners during a bear market. Expected returns and dividend yields rise when stocks fall thirty, forty, or fifty percent but that’s when most investors throw in the towel and sell because it becomes too painful to hold on anymore. Even something as simple as buy and hold becomes difficult in this scenario because for buy and hold to work you must do both when markets are getting crushed.
Those who are able to buy and/or rebalance into the pain when stocks are falling hard will always have a huge edge over those who don’t because many people either can’t or won’t buy when things are the bleakest. The best returns most people will ever find in their lifetime will come when markets are down big.
Having a system about how the world works. The world is constantly changing. Markets participants are continuously updating their data, beliefs, opinions, and holdings based on new information, what’s happening in the present and what they think will happen in the future. Yet no one has a clue what the future holds.
You could argue being flexible helps but being flexible alone isn’t enough. The ability to be flexible stems from having a system in place which gives you a rough outline of the way people, markets, crowds, and the world generally works. None of this is science so any system is more of a guide than a map.
Having a preexisting system about how the world works allows you to take any news, data, opinions, analysis, or market event and run it through the system. You can still be wrong about the implications but having a well-reasoned philosophy or system gives you an advantage because most people or organizations don’t utilize that process.
Understanding the drawbacks to your strategy but investing with it anyways. Every investment philosophy, portfolio, fund, and strategy has its drawbacks. This is one of the reasons it’s so easy for many investors to constantly change what they’re doing. When the perfect portfolio doesn’t exist, you can always be in search of something better than what you’re currently doing.
Having the discipline to stick with an investment strategy despite its obvious shortfalls is the sign of an investor who gets it. If you don’t recognize the drawbacks to your strategy ahead of time it becomes nearly impossible to stick with it when the inevitable bad stuff happens.
Systematically taking your lesser self out of the equation. Outperforming the market is hard but underperforming your own investments is relatively straightforward because everyone has blind spots when it comes to their emotional make-up.
You must recognize your own weak spots and take them into consideration when building an investment plan. The problem is it’s always easier to see the irrationalities in others than ourselves.
The ability to ignore what others are doing with their money. One of the many unintended joys of having children is it has forced me to avoid caring what other people think about me as much as I did in the past. So much of my time and attention is focused on the three of them that I don’t have much time to care about what others think. It’s a wonderful feeling because it frees you up from a lot of unnecessary envy, heartache and stress.
Finding contentment with your investment strategy, style of money management or wealth status works much in the same way. You can’t put a price on the ability to ignore what others around you are doing with their money. There will always be someone getting richer faster than you and many times in dumber ways.
Shrugging your shoulders at those situations to avoid FOMO is an edge few have in the markets.
Getting rich slowly. At the Sun Valley Conference a few years ago Jeff Bezos told a story about asking Warren Buffett some advice on a phone call. It went like this:
Bezos: “If you’re the second richest guy in the world and your investment thesis is so simple why isn’t everyone just copying you?”
Buffett: “Because no one wants to get rich slow.”
The combination of patience and a long time horizon will always be tough to beat in the markets.