Yes or no?

In aviation, there is a safety-related saying that takeoffs are optional, but landings are compulsory. The meaning is self-evident if you think about it for a moment. Before a plane takes off, one can always choose not to do so if there is any doubt about safety. However, once you have taken off, you have to land; there is no more choice.

There's an exact equivalent of this in investing. Just as a pilot can always abort a takeoff if they sense something is wrong, an investor can choose not to make an investment if the risks seem too high or there are doubts about the potential returns. However, once the investment has been made, an investor cannot simply abandon it; they have to see it through until some kind of 'landing' can be made. So, while entering into an investment is optional, exiting it requires landing somehow - whether at a profit, a loss, or somewhere in between. You already have skin in the game. If you ignore the stocks that you own, you could make money, or you could lose it. It's not an option. The strange thing is that in practice, more people seem obsessed with what to buy next instead of worrying about whether to continue holding what they have.

This sounds like an approach that is safety-first in a very determined manner, and it is. It also goes against the basic instinct of many investors - it goes against the kind of psychological makeup that leads people to become equity investors in the first place. They're inherently optimists. You might think that equity investing makes people optimistic, but that's not true. The cause and effect are the other way around. Only people who are inherently optimists tend to become equity investors. To start investing in equities, you need to have a strong, inherent belief that tomorrow will be better than today.

This conflicts with one of the basic tenets of investing - avoiding mistakes is far more important than making brilliant choices. Guided by their inherent optimism, too many investors become fixated on unearthing the best-performing investment when picking stocks or other assets. This mindset pushes them towards constantly switching between ideas, hoping to land on an investment just as it takes off.

The list of reasons anyone might invest in a stock is obvious, like management quality, profitability, growth, valuation, etc. However, investors forget that these should initially be used not as indicators of whether a stock should be invested in but whether it is to be avoided. That's not the same thing. When used like this, these factors are go/no-go indicators, meaning that if a company falls short in even one of these factors, its stock is off the table, regardless of how exceptional the other aspects might be. To take the obvious example, consider valuation. Plenty of great companies are wonderful investments in every way, except that their stocks are overpriced, i.e., the valuation is too high. This means that they should not be touched.

This disciplined strategy ensures investors avoid pitfalls, even if they initially seem alluring. Instead of getting swayed by a majority of positive indicators, they are taught to be cautious and discerning, understanding that one weak link can jeopardise an entire investment. In the volatile world of equity investing, where emotions often cloud judgement, having such clear-cut criteria can serve as an invaluable anchor. Furthermore, by trimming down the vast ocean of choices to a more manageable pond, investors can focus their energy and resources on genuinely promising opportunities. This approach drastically lowers the research load by eliminating large parts of the markets and narrows the universe that we have to consider.

The notion of focusing on what to avoid when selecting stocks is both fascinating and useful. When you identify a concerning flaw in a stock under consideration, saying no to investing in it suddenly becomes straightforward. You can feel highly assured in ruling out inadequate choices. Though saying yes might stay ambiguous, recognising what fails can be done with conviction, and conviction is what investors need.

Also read: An emotionless system