I had two reasons for writing about this book. The first is that it fits well with the comments on my last blog post, where a couple readers discussed their investment strategies. The second reason is that I will present it to the grade 9 class that I taught on behalf of Junior Achievement and introduced to the stock market simulation. It’s the one book that I felt was most helpful with giving me the understanding and confidence I needed to start investing in stocks.
Benj Gallander, the author, is an independent investor who has been actively investing for over 25 years. He has learned a lot along the way, and he shares his knowledge and perspective in this book, in public speeches and in an investment newsletter. (You can find out more here: http://www.contratheheard.com/) Gallander puts forward 13 rules that he feels have contributed to his success. When starting to invest, most people learn in baby steps, doing one thing at a time and adding other components as they improve in sophistication. That’s why I’m only going to comment on the most general of the rules, but I’m sure the other rules are equally applicable.
Rule 1 is: Prepare to think differently. Human beings seem to have a strong herding instinct. We tend to feel most comfortable doing what others are doing, so it’s difficult to stand out by taking an opposing view. Buying when everyone has been buying is what lead people to buy near the top of the tech bubble, and when selling was more common than buying, the stock market crashed. A contrarian, someone who buys when the majority are selling and sells when the majority are buying is most likely to buy low and sell high. Fear and greed are the two emotions that most often move individual investors to action. But those two emotions usually cloud good judgement and cause investors to make mistakes. Think for yourself and stick to your discipline.
Rule 2 and rule 6 are related and both reject the prevalent theory about the mechanical model of how stock market works. The stock market is not as simple as flipping a coin (heads the stock rises, tails it falls). That theory is known as the Random Walk theory, but it doesn’t reflect the huge run ups or precipitous crashes that exist in reality. That’s why calculations of risk represented by standard deviation, or the derivation of correlations, don’t reflect the true extend of potential outcomes. The stock market is a riskier place than mathematicians (or economists) seem to realize.
Rule 3 is to diversify, but not to overdiversify; rule 8 is to look to hit home runs in the stock market. Both of these rules advise against mediocre returns. If you buy an index fund, you are guaranteed to earn the market return (less fees) each year. If you want to beat the market, the most likely way is to own a focused portfolio (fewer than 30 holdings) and to aim high. Of course, there’s a real possibility of under performing the market, too. That’s the cost of making your own decisions.
Gallander also lays out his method of evaluating companies. His strategy could be called “deep value”. He looks for companies that have had some disappointing results or some bad news, but appear able to turn around, hence producing impressive stock returns. A number of the companies they’ve chosen to invest in have been taken over in mergers or acquisitions, profiting the investors and vindicating the research. Their returns are very impressive (over 15% per year compounded for last 15 years) and I believe that their strategy works. It’s somewhat different from my personal strategy, so I haven’t adopted it wholesale, but I feel that I have benefited from seeing behind the curtain.
What is the source that’s been most helpful to you in learning to invest? Do these rules fit with your strategy?