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Feb 1, 2018

The Learning Curve And Historical Performance

by Don MacKenzie

My investing career began in earnest in 2002 when I arranged a $100,000 homeowners’ line of credit to manage my portfolio. My retirement was secure. I had a defined pension plan and a profitable rental property. On the negative side, I had no formal experience in finance, and my mathematical skills were rudimentary. I did not have the skills to evaluate company reports and found even analysts' explanations to be a challenge. My goals were modest. I reasoned that I could learn as I went along and that if I could come close to matching the TSX, I would earn just enough to make the exercise worthwhile. Canada's income tax structure would compensate me for my loan costs and reward me if my earnings came as dividends or capital gains. Theoretically, I could make money even if I just matched my loan rate. Realistically, many tests were to come first, with the lessons to follow soon afterwards. As a former teacher, this still strikes me as unfair, but it is obviously a key element of the learning curve.

I muddled along during the next five years, doing my best to pay attention and learn from my mistakes. In early 2007, I was ecstatic to realize that I had made almost $80,000. I couldn't even think of what to do with that 'surplus' money. Of course, I could buy a nice car, but that didn't seem very imaginative. The negative investing environment which immediately followed quickly revealed the flawed reasoning behind several of my early picks. My low point came in March of 2009 and coincided with the low points of the TSX and the SPX. I had lost 30% of my opening investment and had suffered a staggering 60% loss in a-year-and-a-half. The bank was not about to take my house, but I was not happy and was very glad I had not bought that car.

I needed to do a reassessment. One of my primary rules was always to remain fully invested. I kept that one and added to it the idea that I should trade as little as possible. They were both good decisions. My portfolio went on to seriously beat the indexes and gained 56% in 2009 and 24% in 2010. By March of 2011, my portfolio had established a new high. During the three years [2008-2010] I bought only two stocks, sold none, but had ten bought out and delisted. I had let the market itself shift my holdings in a more conservative direction. My good performance was the result of keeping the stocks I already had and not because of clever trading.

I can recount these events with some precision because I am obsessive about reviewing past performance and decisions made. The time spent on this activity is many, many times the effort spent on researching new buys. I do, and I am sure others would, question the value of this ‘research’. Certainly, the insights I gleaned seem rather limited. However, these insights are necessarily on much firmer footing than any insights that I could gain by speculating in depth on the future. To think I could gain an edge by researching companies and predicting their future is simply ridiculous. If I can’t understand the results of my past decisions, I have absolutely no hope of predicting how current decisions will work out. Recognizing limitations is critical to investing success. Reviewing past performance and decisions helps me to recognize my limitations. My learning curve is much improved by taking note of how my decisions played out. To assist with that I have always subscribed to a portfolio tracker. For a few hundred dollars a year it allows me to keep a record of all of my trading activity and provides a backup for the records held in my on-line trading account. In addition, I keep an investing diary and a list of 'investing tidbits', maxims which have proven their worth. Taken together - records, diary, maxims – they have produced the filter which I use in every ongoing investment decision. The results have been good (five-year 22%) (14% since inception in 2002). As a result, most decisions I make today are surprisingly simple. I am usually just deciding whether one stock, or another, belongs in my portfolio.

Of course, paying attention to your own experience is never enough. You must also pay attention to the market and daily news. This is probably my chief investment activity. Fortunately, much of what you need to know is not in dispute and is readily available. I like to think of it as “unsecret knowledge”. It is much more reliable than the secret tips many investment news letters want to sell you.

I don't know what performance I will be able to achieve going forward, but I do know the process and information I am going to rely on. I choose to continue to face the near-term uncertainty of investing in equities because that is where the money is. I encourage you to make your own investing life easier by setting up your own filters and establishing your own process.

To help with this, I hope in future articles to highlight choices which you can exercise to make your life easier and improve your performance.

A beginning then: a few tidbits which I think are critical to good performance. Do consider including them as part of your own process.

The number one problem for investors is an inability to sustain a constant strategy.

Retail investors greedily invest at the end of bull runs and sell in panic at the tail end of bear crashes. They managed a pathetic 3.7% a year between 1985 and 2004 while the market achieved nearly 12%.1 My policy of always being fully invested neatly, and simply, avoids that problem.

Process is the key element of a sustainable strategy

(See systematic decision making2 at the end of this article.)

Process is more important than anything else. A set process protects you from being continually sidetracked by your emotions. A process set up to reject investment ideas will discourage you from trading and will promote your own tranquility. A sound process also reduces the effort needed to make decisions. 'Sound' is the key word here. If you discover your process has led you to make bad choices, you have to modify your process. Even the best established process cannot be left on auto-pilot. This is so because the half-life of a public company has fallen to about a decade3 and other elements of the investing universe are always in flux.

You can't time the market

Here is one of those “unsecrets” everyone agrees on. The difficulty is that many investors don't realize when they are trying to do exactly that. When your buying or selling decision is primarily based on the ebb and flow of the market, you are guilty of trying to time the market. Momentum traders are guilty, as are sector rotation traders, and chartists. Financial institutions and advisors love the ebb and flow of the market. They like to point out (currently) more profitable sectors. They encourage you to trade to take advantage of the recognizable (in hindsight) patterns. This type of search for more profitable investments is, in fact, based on market timing. You, the retail investor, don’t have to play this zero sum game. You may not be a lucky player. Instead, ignore market volatility and allocate your capital only to those companies which generate wealth. This will take a lot of investment products off your screen and make life simpler. The money formerly syphoned off as trading costs to financial institutions should now show up in your account. Simple, really.

  1. Why The Average Investor's Investment Return Is So Low https://www.forbes.com/sites/advisor/2014/04/24/why-the-average-investors-investment-return-is-so-low/
  2. Systematic Decision Making Are You Trying Too Hard? https://papers.ssrn.com/sol3/papers.cfm?abstract_id=248167 Special Note: A copy of this article sits on my desktop. It is compulsory reading, if you want to succeed. Authoritative and clear, it is difficult to believe it has been downloaded fewer than 400 times since it was written in 2014. This is the single most important article on decision making I have ever read.
  3. Why Half of the S&P 500 Companies Will Be Replaced in the Next Decade. https://www.inc.com/ilan-mochari/innosight-sp-500-new-companies.html

Don Mackenzie, Retired teacher (1998), Landlord (1993-2017). Set up investment portfolio in 2002; lifetime gains 14.5%/yr. to Dec. 2017. Resides in St. Catharines, Ontario. Email: succinctscribe@gmail.com