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Not by technique alone

Following the right processes is important for investing success, but hardly enough


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Over the last few years, I have observed a substantial increase in the proportion of investors who have abandoned the dark mazes of following tips and momentum and started understanding inherent business value and fundamentally driven analysis. Of course, this is not a universal phenomena and perhaps people like me live in a sort of a bubble inside which this transformation is happening at a faster rate. However, the shift is definitely there. Even those who trade on short-term rumours and expectations often do so with the self-knowledge that this is not a great way of trying to grow one's savings. Often, they're sort of shame-faced about it and justify this on the basis of wanting to make a quick buck.

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Does all this mean that if one extends this trend going forward, there will be a greater proportion of investors who will invest better and get better returns? Consider a thought experiment. Let's say, hypothetically, that a majority of investors have read Benjamin Graham's Security Analysis and other works by investing gurus. They keep an eye on the financials and operating parameters of all stocks they own or would consider investing in. They are alert to the performance of businesses that they interact with in their daily lives, as Peter Lynch prescribes. They subscribe to advisory services that themselves follow a strict methodology of fundamental research.

In this kind of a situation, would all these investors have great returns for their investments? Is that all it takes to get better investment returns from investing? The obvious answer should be yes. However, the obvious answer may be wrong, or if not wrong, then at least heavily qualified. Time and again, one sees that investor's actual returns are not reflected in the returns generated by the investments that they put their money in. This is easiest to measure in equity mutual funds, where both numbers can be transparently calculated. One can often see that in a mutual fund where some investors' investments has gone up by multiples over a long period whereas others' has gone up by a much smaller proportion.

Why is this the case? Inevitably, this is a side effect of having the correct knowledge but the wrong temperament. Almost without exception, attitude trumps knowledge and even intelligence.

Even after they eschew trading and become investors, most investors chase knowledge and skills. They believe that that building a spreadsheet that evaluates 20 different financial parameters for a 1000 companies will get you better returns than understanding just the basic facts about 50 stocks. Mutual fund investors spend ages buried in the minute details of funds' portfolios or numbers derived from their returns. Nothing could be further from the truth. What is more important is the ability (or perhaps I should say propensity) to keep calm, focus on basic principles, and not expect unrealistic outcomes. Of course, all these are just words describing concepts that can not be quantified. After all, one person's unrealistic expectations may well look like a reasonable estimate to another.

Another basic principle is that good habits and processes can lead to remarkable success. In investing, this is probably the most important. The final measure of investing success is not the rate of return that you get, but whether you are able to meet your life's financial goals all the way into retirement. For that to happen, the very first requirement is to save, save enough and start saving enough early. The arithmetic of compound investing is an absolute dictator, and gives outsized success to those who start saving as soon as they start their careers and always save a good proportion of their savings.

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