According to Buffett’s Alpha, one of the main reasons for Buffett’s success is, “he managed to stick to his principles and continue operating at high risk even after experiencing some ups and downs that have caused many other investors to rethink and retreat from their original strategies.”
Investors have an uncanny knack for underperforming whatever strategy they claim to be using. The reason is, regardless what method is used, the most critical variable in its success or failure is you. All investment strategies have discretionary and active elements which depend on the actions of a frail and faulty human being, and that human element contains the potential destruction for every investing strategy.
The truth about investing is this: If I gave 100 people the mythical Holy Grail of trading systems, one which could never have a losing year, very few of them would still be using it 10 years later. You’re far too smart for that to happen to you, but what if:
- The first 11 months of use resulted in significant losses.
- A friend of a friend made three times as much last year.
- Any idiot would have known the last 5 losing trades weren’t going to work.
- The average annual return for the previous five years was a mere 1.3%.
- You know the system is wrong about a trade, and the last 3 times you felt that way the system was indeed wrong.
Suddenly it’s not so easy. A nearly infinite number of things can result in the loss of confidence, second-guessing, and eventually abandoning a plan. Perhaps to avoid taking responsibility, investors often spend the bulk of their time on the external: The unending search for some better, smarter strategy, asset allocation, or risk management tool. Beyond pandering to the fruitless desire for certainty amid chaos, that outward focus pushes you to become a kid in the strategy candy store, lured by every new analytical temptation you see. Spend enough time in that situation and even the most resolute will suffer from willpower fatigue.
Instead, the focus should be on the internal: Understanding the feelings and emotions that drive your investment decisions. Remaining consistent over many years despite doubts and conflicting feelings, rather than any particular investing style, is what determine success or failure in the markets. The best returns with any investing style typically occur after prolonged bad patches, decade-long bad patches in some cases, and those higher returns go to those who have stuck it out rather than wandered off trying something new. Good investing should be a pretty boring affair. If that bothers you, find an exciting hobby to stay occupied.
This doesn’t mean you should never change your investing style. You may very well be more successful trying something else. It won’t be because the historical returns are marginally better (and definitely not because the backtested returns are a work of heavenly beauty), but because it’s one you’ll still be using long after it has fallen out of favor.