Basics for a decent investor/money manager

What traits do Warren Buffett, Charlie Munger, John Niff, Bill Ruane, Philip Fisher, John Templeton, Jean-Marie Evaillard and other successful money managers possess in common? It is worth to examine the approaches and traits they have. My goal is to learn from their successes and equally as important, their failures. This involves two main ingredients: 1) The correct principle and 2) The correct person.

At the outset, I must point out that all that are written here do not guarantee you to be truly successful but it certainly can make you an over average, or at least, a decent investor.

The correct principle

Certainly, there are many ways to make money but this doesn't mean every way is the same. For long-term investment success, I strongly believe chances are enhanced when it embodies the following principles:

1. Think of investing as how you would purchase a business, rather than the trading of stocks. Investing today at a particular price is all about laying out cash today in exchange for all the cash flow a business will produce, discounted at an appropriate interest rate, in the future. The key is to pay less than what the business will produce in terms of the total present value over the business life time. Trading price will varies everyday, at times very wildly, but business value or rather, the intrinsic value of a business, hardly varies by much from time to time. Intrinsic value follows the fundamentals of the business while stock prices may or may not follow the business fundamentals. Many times, stock prices are priced to emotions rather than fundamentals. Well, that provides an opportunity for us to take advantage of.
2. Keep your eyes on the playing field, not on the scoreboard. If you invest in a business, it is what the business do, or equally as important, what it does not do, that really matters. If you focus on the stock price and not study the business, it is where most investors are done in. An example is the existing financial crisis, it is what the disciplined banks, like Wells Fargo and JPMorgan, did not do that set them apart from the rest. They did not pursue seemingly good and easy profits by abandoning an approach they understand and is effective for another approach which they did not understand and seemingly profitable business for the short-run, in exchange for long-term risk to the business. Now, we know these "good and easy profits" are nothing but a mirage.
3. Think independently. Do not rely on "expert" advice. Ignore the market, other than to take advantage of its occasional foolishness. We must be able to jot down our reasons for buying. If we buy Johnson & Johnson at $50 per share, we must be able to answer: "JNJ at $50 is undervalued because . . . . ." Ben Graham's dictum told us "the fact that other people agree or disagree with you makes you neither right nor wrong. You will be right if your facts and reasoning are correct."
4. Be flexible to the types of businesses you buy, but never pay more than the business is worth. To cater for errors, always purchase with a comfortable margin of safety unless you are very certain with your analysis. If the intrinsic value of JNJ is $70, do not purchase at $70, if it is selling at $50, buy it for you have a safety margin of 28.5%. As Warren Buffett says, "If you're driving a truck across a bridge that says it holds 10,000 pounds and you've got a 9,800 pound vehicle, [and] if the bridge is 6 inches above the crevice it covers, you may feel okay, but if it's over the Grand Canyon, you may feel you want a little larger margin of safety."
5. Bull market creates a lot of temptations but it is also a test on the investor's discipline. Stock prices run up during a bull market and we know that as stock prices surge, the risk becomes higher and the margin of safety gets narrower. However, part of us, says, "Geez, we don't want to miss the train. There's easy profit to be made as price will goes yet higher." We know it is risky but yet we don't want to miss the train. It is thus imperative to be absolutely discipline in not abandoning an approach that works and is safe for another approach that tempts us with seemingly easy profits but highly destructive and risky. Controlling greed is important - not that we should not be greedy. But the right time to be greedy is actually counter-cyclical as Buffett says, "Be greedy when others are fearful and be fearful when others are greedy." Better be long-term greedy than short-term greedy.
6. Buy stocks as how you buy clothes - only when on sale.
7. There are only three options when we decide whether to buy a stock - in, out, or too hard, as Buffett told us. Accept it when you don't know something. We all have our limited circle of competency. As Thomas Watson, founder of IBM told us, "I'm smart in spots and I stay in those spots." It doesn't matter how large or small the spot or circle is, the important thing is to recognize the limitation of the circle and stay within it. We do not need to know everything. As long as we understand something better than others, we have an edge.
8. The pain of losing a dollar is double the joy of gaining a dollar. Focus on avoiding losses, especially permanent loss of capital, and then think about potential gains.
9. Find one-feet hurdle to step over rather than ten-footer to jump over. Businesses that require the least changes and are simple are superior over businesses that involve lots of changes, innovation and are sexy. Sexy business as in sexy ladies, get us in trouble. Buffett said, "We look for businesses that in general aren't going to be susceptible to very much change."
10. Invest only when the odds are highly favorable, and if you find it, you must be able to bet heavily. Investors at times have been overly sold on the idea of diversification or dollar-averaging, for fear of having too many eggs in one basket if the bet turns sour. The key here is how well you understand what you invest in. If you understand it perfectly, you need not diversify as it makes no sense to give up something that has a higher chance for a higher return for something that has a lower chance for a higher return. The depth of understanding also affects the degree of margin of safety you need. The more you understand, the less you need in terms of margin of safety and degree of diversification.
11. Do not focus on predicting macroeconomic factors.
12. Always be flexible. Be able to recognize mistakes immediately. There's no shame with being wrong. The only shame is being unable to recognize mistakes. Ability to question and discard your best loved ideas if it is proven wrong is not very common but it is certainly important.
13. Beware of technical analysis, momentum trading, or any geeks who focus much on mathematical modeling. The "quant" or "technician" tries to predict stock movement through the shapes on a stock's chart, without reference to value. When you come across someone who advises a stock at $50, "seems to be poised for a breakthrough to the $54-56 area, although a stop-loss order should be placed at $47," that is an antithesis to the principle of investing.

The correct person

We have identified the principles - by no means, exhaustive - necessary but yet insufficient for long-term success. The other ingredient is the correct person. The following provides some clues on the characteristics successful investors should have:

1. Patience is a vital virtue. Buffett constantly reminds that you should never buy a stock unless you would be happy with it if the stock exchange was to close for the next five years.
2. Having the right emotion is important because we are easily affected by the movement of everyday trading price.
3. High intelligence is not a necessity for successful investing. Buffett noted: "Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ." What you need is just a reasonable IQ and the right mentality and emotions.
4. A flair for numbers is important but do not be obsessive in it to the decimal. High advanced maths model is irrelevant.
5. Be humble and check your ego while staying confident with what you believe in. Almost all money managers have confidence in abundance but few are blessed with humidity. The moment arrogance creeps which is fairly easy when your portfolio is on the rise, you become overconfident. The worst kind of overconfidence is to assume success is due to skill rather than because of "when the tide raises, all boat raises." Always ask if your success is due to skills or market conditions. Overconfidence is the start of most disasters because it creates a potential to blind and hinder a person objectivity. They forget to question themselves and assume what was successful in the past will be successful in the future, which often isn't.
6. Be able to sit on your butt. "The game of investing is one of making better predictions about the future than other people. How are you going to do that," Charlie Munger said, "One way is to limit your tries to areas of competence. If you try to predict the future of everything, you attempt too much."
7. Successful investors neither take any comfort in standing with the crowd nor derive pride from standing alone. Bargains are rarely - not never - found with the crowd. When most people head for something, it drives up the desirability of that something, which means also its price and thus, lower its margin for profit. This is simple economics of supply and demand. The more people want it, the higher the price. The less people want it, the cheaper it is. But beware of the value trap: the key is to identify which are truly cheap and good, not cheap and no good.
8. Always recognize it is hard, if not impossible, to find a bottom. If you find shares that are low in prices, they don't go up suddenly. Most likely, it will fall much further, at times, even 60% lower. But it doesn't matter. If you buy at $50, and it drops to $20, but in 5 years, it is worth $150, $150 is what matters, not $20.
9. Be as discipline as you are when you buy as well as when you sell. If you purchase any investment, say a house, at $100,000, for which you know for sure it is worth $600,000, and if someone comes by and offer you $200,000, you should not sell. And if you reject the first offer, and the next day, another buyer comes by and offer $150,000, you should not feel discourage and sell due to desperation, thinking that if you reject the second offer, the next offer may be lower. The key is to come to peace with your own valuation and reasoning. If you know perfectly well what you are purchasing and $600,000 is the intrinsic value, why sell at $200k, $150k, or even $400k? The only time to sell below the intrinsic value is: 1) if you do not know perfectly well what you purchasing, then you should sell at $400k or even lower; or 2) if you can find a better investment that is more undervalue than what you hold. Consider the opportunity cost of all alternatives.
10. Have passion and love what you do. In Buffett words, one must be able to "tap dance" to work.
11. Investing is a life-long education. He or she must be an avid learner. The moment we stop learning, we are one feet in the grave. Evolution is the only constant so learning is a must, not a choice. If you find yourself a little bit knowledgeable or smarter when you sleep as opposed to when you wake up earlier, you are partly successful.
12. Emotions are not part of decision making. Analysis of hard facts are.
13. For any money manager, three traits are must-have, they are: 1) Integrity, 2) Intelligence, and 3) Passion (as mentioned above). What is most important is integrity for which if it is missing, having the other two create more harm than good to investors who commit money with them. As Buffett says: "It is far easier to rob with the point of a pen than with the point of a gun." Unethical money managers will outwit unknowing investors - think of Bernie Madoff. He probably has both intelligence and passion but no doubt a lack of integrity. "Honesty is the best policy," as Ben Franklin told us.
14. Never allow greed to take possession of you so that you become in a hurry or afraid to miss the boat. Neither should you be too interested in money, you will kill yourself. However, if you are not interested enough, you won't go to the office. Instead, you must be animated by controlled greed, and fascinated by the investment process, i.e. to enjoy the game.
15. Possess the security and self-confidence that are backed by knowledge, without being rash or headstrong. If you lack confidence due to a lack of knowledge, fear will drive you out at the bottom. Nervous investors who aren't armed with the right facts have the habit of selling out when they go down.
16. Must be logical and think objectively.
17. Last but not least, ssk who is the idol of this person. Most successful investors have some common idols. Warren Buffett admires Benjamin Graham and Benjamin Franklin. Charlie Munger admires Benjamin Franklin. Bill Ruane admires Benjamin Graham. John Niff, Mario Gabelli, Michael Price and John Bogle are all influenced by Graham as well. If you draw a chart, you probably would be able to link a lot of these successful money managers back to the village of Graham and Doddsville.

The two main ingredients for a decent investing career are actually joint at the hip - not mutually exclusive. Some characteristics of the principles are also the characteristics the investor should possess.

Much of what have been written may seem obvious and common sense, but when it comes to putting to practice, majority of money is managed by people who neither have the correct principle nor the correct personal characteristics. After all, common sense aren't that common.

Not all investment managers who have a stellar records are good managers. If you have 10,000 monkeys throwing darts to select stocks, it is certain that a few of them will end up with stellar records due to randomness. This randomness applies to top-performing money managers as well but would they be able to outperform in the future? Of course not for they lack the right ingredients. The luck of these random few will certainly run out as long as they are willing to play the next round continuously till the game ends. Luck, as the dictum says, only "favors the prepared mind." The ingredients mentioned here are part of the preparation.

Thus, these traits are not only useful for evaluating professional money managers but also invaluable in helping you decide how to pick stocks for yourself.

Readers, what do you think? I am as eager to learn from you too if you have any thing good to add.