In every discipline you will find the amazing success stories, the expert players and the gurus with the huge following. The financial and investment industry is no different. It is full of legendary investors who have made millions and billions of dollars and who seem to have the answer to all the questions.
Although much can be learnt from those who have been there before and who have succeeded, mirroring some of their investments for your own account might not be as good an investment strategy as you might think. There are several reasons for this.
Smarts Are Not Enough
First off, if you follow the financial news headlines for a while, you will see that even the most knowledgeable do not always get it right. Two recent examples include George Soros and John Paulson. Soros, who became famous after nearly breaking the Bank Of England, starting taking a short position in the market back in early 2016. The market continued to rally into 2017 leading to a more than one Billion dollar loss. Paulson, famous for the largest trade ever when he made billions during the stock market crash and housing market bubble, lost more than 52% of his fund’s money in 2011.
Why is this? This is because no matter how good a grasp of economics you have or how smart or connected you are you can never know what’s going to happen in the future. There are way too many variables, some of which are unpredictable. No one knows when an unhappy student somewhere in Africa is going to light himself on fire to protest his life’s hardships and inspire people across nations to topple their governments, start civil wars and allow for the rise of extremist regimes. Thus, luck is always a critical component of success. From being at the right place at the right time, to meeting the right people to coming across the right piece of information, luck is always there playing it’s part.
An interesting side comment here is that when John Paulson was trying to get investors to put in monies into his new fund to short the housing bubble, he encountered a lot of resistance. This was because he had been doing mergers and acquisitions before and so people did not look at him as an expert on the housing market. After his huge success with the housing market crash, then people saw him as a guru and money came in more easily. Unfortunately as we mentioned above his bet on gold did not do so well and he lost a lot of money for his investors.
Exits Are Just As Important
The second reason why I avoid making an investment based on a news story I’ve heard is that knowing when to get out of an investment is just as important as knowing when to get in. Thus buying into an investment based on published news that your favorite guru has just added that investment to their portfolio might leave you exposed if no news is published when the person you’re following reduces or closes their position. In addition there might be a significant time lag between when the guru made his move and when you find out about it. Depending on the situation this delay could make all the difference.
Money Management Is Key
The final and probably the most important reason why it might not be a good idea to shadow an investment of some guru you read about on yesterday’s blog is that you probably do not know what part that investment plays into that person’s overall portfolio. Thus you do not know the complete story. As any successful investor would agree, well thought out money management and portfolio allocation are a big part of success. As discussed above, nobody gets it right all the time. Thus knowing how much money to allocate to one investment as compared to others in your portfolio is just as important as finding a good investment. The potential downside of an investment is just as important a consideration as knowing what the potential upside could be. If things don’t work out as planned you need to be able to have enough resources left to keep going forward.
The Case of Warren Buffett
One of the richest people in the world and a favorite for the title of the greatest investor of all time, Warren Buffett has made billions following a value based investing approach. Although many might think that Buffett is a one of a kind stock pick wonder, as described in the paper Buffett’s Alpha his success can be attributed to his systematic approach and the use of cheap leverage. This steadfast commitment to stick with his system even during tough times and down years has been his path to success.
The Universal Truth
The underlying message in the above paragraphs is that investing is a statistics game. No matter who you are and what your investing approach is, you are always going to win some and loose some. I prefer the quantitative approach because it tells me what my odds of success and expected gains are at the outset, eliminates subjectivity and provides me with a clear road map of how to achieve my goals. In addition, since I know what to expect at the outset, I can immediately allocate my capital such that I can take full advantage of the best opportunities while hedging myself against risk through proper diversification.