Life is like a limit function where one is always tending towards something.
In the course of tending towards something, the proactive few often push themselves. A seemingly harmless by-product of this quest is the tendency to strive towards perfection; the aspiration to do everything right to the extent possible and minimize errors & detours along the way. Only that this is a misguided expectation that tends to do more harm than good for this category of people.
The best people in any profession make mistakes, even after they reach an elite level of performance.
Warren Buffett has made many investing mistakes over the past two decades, this from a man who is 90 years old and has been at the game longer than most investors have been alive.
Roger Federer has made many mistakes, including unforced errors on match points on his racket when all he had to do was to hit the ball into an open court.
The best managements make capital misallocation decisions every once in a while. They enter into business segments that are dilutive to the interests of the organization in the long term.
The best salesmen blow deals every now and then, from a position of strength.
Couples who have been happily married to each other for more than a decade still manage to misinterpret communication and have the occasional tiff.
Mistakes will always be made, no matter how hard we try not to. It is just that those who are successful at something manage to do enough things right to ensure that these mistakes don’t matter too much.
No high-level philosophical drivel this, obvious implications in investing too.
In case you haven’t yet, please go through the Investment Process page. The process is an indirect acknowledgement of the fact that strike rate may never be 80%, leave alone a 100%. Which is why it is important to have a negative list of what one will not do. Avoid pockets where costly mistakes can happen and you address survival risk right away.
Focus on what remains after applying reduction principles and try getting to a strike rate of 65%. Which means on 2/3rd of the investments you make, you absolutely do not lose money over 5 years. On some of these you might just about eke out a sub optimal FD like return but you also have some home runs that make up for some of these sub optimal performers.
Go back to all the competitive exams you’ve written as a student. In CAT and GMAT, one has to demonstrate competence across all sections before attempting to maximize score in one section. A 100%ile in Verbal Aptitude cannot compensate for a 70%ile in QA. Though a 99.5%ile in VA can compensate for a 91%ile in QA. At the same time, a 95%ile across all three sections isn’t good enough to get you interviews with the best colleges. Once basic mistakes are eliminated, one has to try and maximize the score.
Even in business, the best organizations place a premium on avoiding large mistakes. But once they ensure that, they try to cement dominance in their chosen segment and take one calculated gamble after another.
The sequence for success at most things appears to be
1. Start with a good base of knowledge, awareness and competence
2. Ensure that you do not make basic errors that can put you out of the race
3. Once survival is ensured, you focus on excellence, take calculated risks and keep pushing the boundaries
If one is in stage (2), the focus should be on having enough experience and enough discipline to minimize costly errors. But if one is in stage (3), one should be willing to make a few more mistakes in the quest for excellence. Spending too much time stuck in phase (2) may get you outcomes that are above average but it will never net you excellent outcomes.
The whole of passive investing focuses on stage (2) and encourages investors to stay there rather than strive to move into phase (3). This is excellent advice for an overwhelming majority of the investors but may not be applicable to a tiny set of investors who have the potential to outperform the market over the long term. For this reason, the whole passive vs active investing debate is incomplete without having an appreciation of who it is being applied to.
For a good active investor, passive investing will always appear sub optimal.
For the below average active investor, passive investing will look far more optimal and simpler.
If you are someone aspiring to move into stage (3), mistakes should no longer worry or scare you since you already have the competence to ensure that a few mistakes won’t make too much of a dent. This is where the aspiration of perfection becomes a drag rather an asset. In the quest for the next great investment idea, one might have to make and live with a couple of mistakes. The last thing good active investors should do is to beat themselves up over a few mistakes, because for them the next 3-4x might be round the corner sooner than they think.
Today when I look back at the past 5-6 years, 80%+ of the stocks I have bought since 2016 have made me money over a 5-year period. Even the bulk of those bought at the peak of the 2018 small cap frenzy have netted me returns superior to that from an FD. Some of these stocks have underperformed the index but at an overall portfolio level the return continues to beat indices due to a few multibaggers and two superlative performers that have netted ~9x and ~6x over the period.
If you want to be a heavyweight boxer, taking blows is something that you need to get used to. If you don’t have the stomach for the blows, you might want to aspire for something lesser in life. Sometimes the fight looks like a mismatch but this is where self belief comes handy. Active investing for the most part feels no different with data telling you that it is next to impossible to beat the index consistently over the long term.
Steve Davis, 6-time world snooker champion who was famous for his mental fortitude at his prime once said that the ability to play like you don’t care about the result when it matters the most is a superpower.
He is indirectly saying that if you keep worrying about making mistakes, your worry will always weigh you down and keep you from being the best you can. Realism can be a liability for outliers.
Beyond a threshold of competence, the person with the higher level of conviction in his own abilities (after doing the basics right) is more likely to excel than an equally competent person plagued by self-doubt who is too worried about making mistakes.
