One of my favorite pieces of advice is this: Have mentors you’ll never meet. In this case, we’re going to assemble a list of the best investors in history, understand how they think, and use them to improve our investing decisions.
As we go through this list, please remember our goal here at 3MM: We want to build a million-dollar small business that can be run in three months or less. One of the cornerstones of our approach is a solid investment plan that yields solid results.
After all, when it’s all said and done, the investment portfolio we have built will be the golden egg our goose has laid. It’s what we will use to transfer our excess wealth to our children or to the societal cause of our choosing.
So let’s get started.
First we’ll assemble our team, then we’ll look at their biggest, greatest ideas, and finally, we’ll pull all of those lessons into our own investment plan.
First: Who are the best investors in history?
We chose this list based on the best investors (measured by both returns and reputation) who we can actually learn from.
So yes, there might be people out there who have had higher compounded returns than the people on our list, but if their success was due to something that we can’t emulate (like an angel investor that can invest in potential unicorns) or learn from (like someone who struck it rich through speculation or luck) they didn’t make it on the list.
Our shortlist for best investors:
- Warren Buffett
- Charles Munger
- Benjamin Graham
- Howard Marks
- Peter Lynch
If you’ve checked out our business and investing guides, you know that the secret and the backbone of the 3MM program is borrowed from none other than Berkshire Hathaway, which is run by two of the best investors in history, Warren Buffett and Charles Munger.
So if our small business is modeled after Berkshire, it only makes sense that our first two best-ever investors would be the dynamic duo at Berkshire’s helm.
Warren Buffet
Buffet often gets slapped with the ‘value-investor’ label.
But that’s not accurate at all. Why not?
Value investing is the art and science of buying a stock for less than it is worth, or “at a discount”. There are a hundred ways to determine when something is ‘trading at a discount’, but Buffett almost never does this. So why is he often called a “value” investor?
Because he started out that way.
But he switched (thanks to the advice of his friend, Charlie Munger) to something you might call “Growth at a Reasonable Price”.
What does that mean?
The problem with value investing is that often when something is selling below its value, it is because the underlying business has stopped growing. And the market is not friendly to stocks that are not growing their earnings.
So yes, you can buy it cheap, but it will probably stay cheap.
Instead, Buffett buys companies that have good prospects and a reasonable likelihood for growth. The market value of these stocks will continue to rise as the underlying business grows its earnings.
The trick then is to pay a price that makes reasonable sense. Sometimes that means paying what many people think is too much money.
The key is to focus on good businesses.
But how do you know you are buying a good business? Buffett follows these investing tenets.
Investing Tenets:
Invest in Managements
When Buffett buys a stock, he’s actually buying the management of that underlying company. He does this when he buys whole businesses as well.
Basically, he looks it like this: he’s buying a small slice of a business, so he wants good people to run it for him. He wants it to be a completely passive investment.
Are they candid and honest?
He reads through the annual shareholder letters and SEC filings to get a sense of how honest management is. Do they own up to mistakes? Or are they going to try to cover up errors?
When they describe the market conditions facing their company, are they likely to be telling the truth?
If they give you an estimate of earnings growth, can you trust them?
Do they behave in a rational way, or are they driven by emotions?
One excellent test for that last point is the One-Dollar Test.
The One-Dollar Test
Does Management regularly produce at least one dollar of market value for each dollar that it retains?
It works like this: After management has paid all of their bills, salaries, and interest payments and replaced all worn-out equipment, are they reinvesting in new projects that earn above-average returns?
As long as that is true, the market value of the company will increase by at least one dollar for each dollar they keep.
If it is not true, then rational, honest management will not keep the extra money.
Instead, they will pay it out to shareholders as dividends.
AT&T pays out almost all of its earnings as dividends. Does that mean that management is not honest?
Not necessarily. But it does mean that management can’t think of anything better to do with the money. Maybe that management isn’t all that great. Or maybe that company has just reached the limit of its growth (which is fine; if left to grow forever, all companies would reach that stage eventually).
Either way, they are not good a steward of my money.
If, on the other hand, the management of a company can use those retained earnings to cut costs, or start new programs that will increase profits, then the market will bid up the price by at least as much as they retained (excluding temporary scares, panics, and shocks to the market).
That’s who you want in charge of your money.
Invest in Moats
Buffet (and Munger, mentioned next) talk a lot about companies that have moats. What’s a moat?
A moat, when talking about businesses at least, is the qualities of that business that makes it impervious to a competitive attack.
What makes a product difficult to copy?
Sometimes it’s a truly unique product or service that would just be too difficult to compete with.
Think about Google. When it comes to searching the internet, how would you ever compete with Google? Even if you had all the money in the world, how would dislodge Google from the collective psyche as the place to ask your internet questions?
I mean, their name has become the verb for searching the internet, for crying out loud!
Sometimes, a moat comes from switching costs or contracts or patents. You can’t copy a new pharmaceutical because it’s literally illegal for you to do so. You can’t create a new non-QWERTY keyboard layout because before anyone switched to your product they would need to pay the ‘cost’ of learning a whole new typographical layout.
Most of the time, though, moats come from branding and marketing. Apple and Coke are great examples.
Apple doesn’t really do anything special. The phones they make could be copied by any number of other manufacturers.
Coke might have had a secret recipe 100 years ago but modern technology could figure that thing out in no time.
So why don’t people run out and copy them?
Because it would never pay to do it. Imagine it: you buy ads during the Super Bowl to announce that your phone is identical in every way to an iPhone, or that your soda tastes exactly like Coke…
How many people will believe you?
You’ll just look crazy.
That’s the power of marketing.
(Actually, marketing is much more powerful than that. If you gave someone a drink that was chemically identical to Coke but told them it wasn’t Coke, they would either 1) just think you were lying and that you actually gave them Coke, or 2) they would swear that what you gave them didn’t taste like Coke.
In short, our actual senses can be altered by marketing. Creepy.
Why Do The Best Investors Focus on Moats?
All companies will eventually settle into a ‘mature’ phase. In this phase, they will have grown as large as they can and they will no longer be able to earn high returns on their capital.
Think of my AT&T example from above.
If a company lives long enough, it will happen. No tree can grow to the sky.
But, if a company has a strong moat, it will take much longer to reach that point.
Why? Because they tend to have high returns on capital. That means they might only need to invest $1 to grow earnings by $0.20 (a 20% increase).
And that means more time for your money to compound.
Meanwhile, a company with no moat will have lots of competitors. They will compete on price, constantly undercutting one another and driving profits down. A company like that can barely hope to invest $1 to grow earnings by $0.10 (a 10% increase).
They are living on borrowed time. They will either stagnate or be taken over by a stronger company with more income.
Moats help you protect your investment for the long term and keep you locked into a high return on capital business.
Margin of Safety
I think everyone on this list utilizes this concept in one way or another.
This was one of the cornerstones of Benjamin Graham’s (father of value investing, covered later) investment philosophy.
In short, a Margin of Safety is the difference between a stock’s price and its intrinsic value.
Buffett, who was a student of Ben Graham, has stuck with this concept and uses it to achieve his own ‘first rule of investing’: Don’t lose money.
Yes, Buffett believes in buying good management. And yes, he believes in buying companies with favorable long-term economics (ie. deep and wide moats).
But, he won’t pay too much for a company, even if it has both moats and management he likes.
So how do you know when a price is too much?
You need to calculate its intrinsic value. You want a gap where the cost is below the intrinsic value of the business.
And the bigger that gap, the more Margin of Safety that stock has.
Why does that gap give you a Margin of Safety?
Because all stocks return to their intrinsic value, given enough time.
So if you bought a stock at a price that was 40% below its intrinsic value, that stock would, given enough time, rise and you would gain 40%.
That sounds great! Except…
If it takes 10 years to make that 40%, you’d only have returned about 3% per year, which is not a good return. It would barely keep pace with inflation.
But at least you didn’t lose money!
By the way, this is why Buffett is not a value investor. A true value investor would see that 40% discount and hit the buy button, but Buffett wants a 40% return and reasonable prospects of growth.
So he wants the Margin of Safety to protect himself, but that is just one part of the equation. He also wants good management and business prospects that make it likely to regain its value and continue growing in a short amount of time.
How do you calculate intrinsic value?
That needs a whole post of its own. There is a shortcut, though. You can always use online calculators. But be warned, the real benefit of intrinsic value comes from understanding the process.
So even if you end up using calculators, please take the time to learn the theory behind it.
Plan to hold for the long term
Buffett often says that his favorite holding period is ‘forever’.
He (and Munger) also often say that you should never interrupt the compounding unnecessarily.
When you have a company that has good management, a solid moat, and can reinvest extra profit for more profits later, you want that cycle to happen as many times and for as long as possible.
The stronger the moat, the longer the compounding can run.
This means that if you make a purchase, you better be in it for the long term.
Short-term investing means trying to time that market, something that has been proven impossible time and time again.
So instead we should try to profit from short-term market irrationalities. When the price drops meaningfully below intrinsic value, and we have faith the company will continue to grow in the future, we buy and we wait.
Even after the stock has returned to a fair price, we wait.
Even if the price has gone above fair value, we wait.
As long as the company has reasonable prospects of growing and compounding its earnings, we stay in the position.
So when do we exit?
Only after we find an opportunity that has an even better chance of compounding at a high rate.
Usually, it goes like this:
We bought a stock that meets the criteria (moats, management, margin of safety). Years have passed.
The stock has reached maturity. Its return on capital has dropped to average levels.
It’s still a fine business. It is still well-run. There are just no more markets left for it to grow into.
We can either keep it and live off the dividends. Or we can sell it and reinvest the money in another opportunity.
Which do we choose, dividends or sell-and-reinvest?
Depends on the market at the time, but we prefer to reinvest. It’s more tax efficient.
Charles Munger
Charles (Charlie) Munger is Buffett’s right-hand man and life-long best friend. Charlie’s investing style is, at the bottom, the same as Buffett’s.
So why bother reading about him?
Because the way he thinks about investing is different and maybe even more valuable to you and me (ie non-billionaires).
Before Charlie came along, Buffett was firmly in camp value-investing. He only bought things that were cheap.
But Charlie convinced him that is “better to pay a fair price for a great company than it is to pay a great price for a fair company”.
Charlie, more than anyone else, helped to Bring Buffett around to the ‘growth at a reasonable price’ method of investing. But how did Charlie come to that conclusion?
Munger is an avid lover of books and wisdom. He set it as a goal for himself to gain worldly wisdom in a systematic way. Much of this wisdom that he was gaining, gave him insight into investing.
So what were these insights?
Investing Tenets
Opportunity Cost
At the heart and soul of Charlie’s approach to investing is the notion of opportunity cost.
That is the idea that you can never invest the same dollar in more than one investment at a time. Therefore, each dollar must be invested where it has the best chance to compound.
Your best business idea must be weighed against your second-best idea. If something isn’t better than what you already have, it isn’t worth doing.
Say you have an investment in Apple that is paying $5 per share. But then you hear about some hot new stock tip.
So you look into it. You could either invest $1000 into Apple and gain about $40 in earnings, or you could buy the hot new stock and get $30 in earnings.
Many people would jump on the hot new stock tip because it is exciting and popular and everyone else is doing it…
But Munger would point out that this is irrational. It is emotionally based investing and makes no logical sense.
Another way to think of this is to consider Warren Buffett’s haircuts.
Munger once pointed out that each of Buffett’s haircuts actually cost $1 million dollars.
Why?
Because the money he spent on haircuts could have been invested. And because Buffett generally gets 20% per year compounding return, spending the money on haircuts instead is the same as losing 20% per year on that money.
Circle of Competence
Both Buffet and Munger advocate staying within your circle of competence. That means being honest with yourself about what you do and don’t know about.
If you don’t know about it, don’t invest in it.
(This is why they stick with simple businesses they can understand).
Munger is fond of quoting Richard Feynman by saying “You must not fool yourself, and you are the easiest person to fool.”
He advocates being real and honest with yourself about what you don’t know. This heavily relates to his next Investing tenet:
Inversion /Avoid Bad Decisions
Another example of Charlie’s multi-disciplinary approach is the advocacy of the concept of Inversion.
Inversion, which is the fundamental idea behind algebra, is the act of solving problems by reasoning backward.
The best way to achieve an outcome is by thinking of all the ways you would fail, and then avoiding them. It’s often easier to avoid bad outcomes than it is to achieve a specific good outcome.
This is why Charlie likes to say “Tell me where I’m going to die, so I never go there.”
But you can only solve by inversion and avoid bad outcomes if you are within your circle of competence.
How does this play out in investing?
Try to think of a handful of failed investors. These might be people you know (friends and family who have had bad experiences in the market or lost a lot of money) or they might be famous failures like Lehman Brothers, Enron, and Salomon.
Think of the mistakes they’ve made.
Uncle Arty always got his investing advice from pundits like Jim Cramer.
Aunt Sue lost a bunch of money in 2008 when she panicked and sold at the bottom.
Grandpa has never lost any money in the market because he keeps all his money under his mattress and ignores the fact that inflation has eaten almost half his wealth since retirement.
Enron collapsed after buying insanely complicated financial products that literally no one fully understood.
By knowing where all these people financially “died” and then never going there, you are setting yourself up for great success.
Objective, Rational, Independent Thought
All of this hinges on being very objective and rational in your thought process.
(Remember, you are the easiest to fool.)
So when you make investment decisions, you need to be on the lookout for emotionality that might lead you away from a rational decision.
Are you investing because the company has good economics or because you like some aspect of the company?
(I knew a guy that invested a ton of money into Activision because he liked the latest World of Warcraft patch. Activision may or may not be a good company, but his reasoning was flawed. He needed to at least look at the effect that patch was likely to have on Activision’s bottom line.)
It also works the other way. Are you avoiding investing because of negative emotions? I have seen far more wealth destroyed in my life by people who are too afraid or are too affected by negative news stories to invest.
This brings me to the importance of ‘Independent thought’.
Investing Like The Best Means Think For Yourself
You must think for yourself and come to your own conclusions.
Jim Cramer is wrong more than he is right.
No pundit can predict the markets (if they could, they wouldn’t be pundits).
And the nightly news gets paid way more when they feed you doom and gloom.
You must build for yourself a fortress of thought. You must be extremely selective of what outside opinions you let in.
Want to know one way to do this?
I deleted news from my life.
We went to all-streaming TV, so we don’t get commercials or news. I hand-curated my feeds to only allow stories that are not likely to have investing-related info. I have blocked Motley Fool, Seeking Alpha, Yahoo Finance, and any other financial news media.
What do I let in? I read articles from Business Insider and the Economist or any other business-oriented publication that does not have a reputation for yellow journalism.
I want these in my life because they help me grow my circle of competence. I want to stay apprised of the business world (please don’t become a hermit).
And even then I have to be careful. Even my favorite publications have sinned and fallen short from time to time.
What to know a trick I use?
Here’s my litmus test: The moment I get the sense that the article wants me to feel something (rather than be informed about something) I stop reading.
Ever-growing, Multidisciplinary Knowledge Base
So there is a balancing act. You must continue to grow your circle of competence.
You must continue to increase the number of useful models you use to make decisions.
But you must not be tempted by emotionality. You must stay objective.
The best way to do this, according to Charlie, is to collect and use a wide range of basic lessons from various disciplines.
In a single business decision, you might use lessons from Algebra (invert!) microeconomics (switching costs), and History (The California Gold Rush) to decide that a semiconductor equipment manufacturer has a pretty strong moat that seems likely to stay.
(By the way, the Gold Rush model goes like this: During the US gold rush, the average person who went in search of gold made no money at all. The ones who made money did so by selling shovels. The ones who got rich built a moat around a brand that is still here today, Levis).
The more discipline you can bring to this process the better.
Munger recommends creating a mental dinner party of the eminent dead. Get to know the thought processes of great thinkers in different fields and then (mentally) invite them to dinner and ask them what they think.
Business Oriented Investing (as opposed to market analysts or securities or economics)
All of this, the careful cumulation of rational knowledge, the self-protection from outside influence, the objective, rational thought…
It all serves one purpose: To buy businesses.
Not stocks. Not pieces of paper to be traded easily on an open market.
Businesses.
Munger (and Buffett) hinge on everything on the belief that what you buy when you buy a stock is a real and tangible (albeit fractional) share of a company.
As long as you can maintain that focus, you will find it much easier to ignore the news and opinions of others.
Benjamin Graham
Ben Graham is the father of value investing. He was Buffett’s primary teacher in the ways of investing.
Graham advocated something called a “cigar butt” strategy. That is buying distressed companies that have ‘one last puff’ in them before they go out.
As long as you bought these for less than the net value of their assets, you could make money.
And Graham did. Lots of it.
But this doesn’t really work anymore (better accounting practices and technological advancements have made it hard for liquid wealth to hide from investors) and even if it did still work we wouldn’t do it around here.
Why not? It doesn’t give us the long-term predictable earnings we need to create a million-dollar business that can be run in three months per year.
So why are we learning about this guy?
Graham is still responsible for two of the greatest concepts in the investing world, both of which work superbly for our 3MM system.
Mr. Market
Warren Buffet has said investors really only need two well-taught classes: How To Value A Business and How To Think About Market Prices”
Well, Graham’s greatest lesson addresses the second of these.
Mr. Market is a metaphor that helps us think about market prices.
It goes like this:
Mr. Market is your business partner. He’s a bit… unstable. Sometimes he wakes up in a joyous mood and wants to buy everything from you at exorbitant prices. Other days he wakes up depressed and wants to sell things to you at depressed prices.
Graham says that if you want to be successful, you need to buy from Mr. market when he is depressed and sell to him when he is happy.
By imagining the stock market as a person, it makes it easier to see that the market has its own mood swings. And you can take advantage of that for profit.
Mr. Market Investing Example
A recent example (as of this writing) has been Google. Its price has been low for a little while now. And Google has recently reported below-average earnings (due to a slow-down in ad spending related to economic uncertainties). So, of course, Mr. Market is sad.
But I can find no evidence anywhere that anyone thinks Google will be reporting below-average earrings forever. Or that anyone thinks Google will stop growing. Or that Google is in financial trouble.
But Mr. Market tends to only think of the immediate future. So yes, if an economic slowdown does happen, Google’s earnings will be lower. Maybe a lot lower. But will they still be lower ten years from now?
Unlikely.
And in the meantime, Google has huge plans for reinvestment in any number of projects that could earn healthy returns down the road.
So this might be a time to buy from a sad Mr. Market.
Another recent example (again, as of this writing) is Tesla. Mr. Market has been insanely happy about Tesla. Earlier this year it was trading around 100 times its earnings.
That means if you bought it at that price, it would take around 100 years to pay for itself.
The company will have to increase its earnings by 38% per year for the next 5 years just to end up with the same price-to-earnings ratio as the S&P 500.
So Mr. Market can be a little crazy at times. We just have to realize that when he is sad and prices are down, it represents an opportunity, not failure.
Low stock prices are great news, as long as we are in a business we still have faith in because it gives us a chance to expand our ownership.
Business-Like Investing
Graham’s second great contribution was his statement that “Investing is at its best when it is most business-like”.
Now, don’t get this confused with Munger’s advocacy of investing in businesses. The ideas are similar, but they are not the same.
Graham is saying that when you make an investment decision, it should be made following the same principles that you would use to make any other business decision.
In short, your investments should be part of your business.
That means doing the math. Using numbers. You would never buy an expensive new espresso machine for your business because someone on TV said they loved Cappuccinos. So why would you buy a stock because some pundit told you to?
When you buy a stock, you need to realize that its earnings now become part of your earnings. Remember Tesla trading at 100 times its earnings? If you had $10,000 to invest in your business, would you rather buy $100 of Tesla’s earnings or $500 of S&P 500 earnings?
Both cost you the same. The emotional choice to buy into the hype of Tesla. The rational business-like choice is to buy the S&P 500.
Howard Marks
Is the co-founder of Oaktree Financial, the world’s largest investor in distressed securities. He has written two books, The Most Important Thing and Mastering the Market Cycle.
For what it’s worth, I love both of these books, but The Most Important Thing is one of my all-time favorites.
Many of his investing tenets overlap with Buffett and Munger (in fact Buffett once said that he has learned much from Marks, both through personal emails and by reading his books).
What follows are the tenets that Marks advocates. Most of these are gleaned from memos to employees of Oaktree. These and many others can be found in The Most Important Thing.
Control Risk Above All Else
As an investor in distressed securities, you can bet he’s obsessed with controlling risk.
Even though we don’t invest in distressed debt in our investment philosophy, the tenet still stands.
Have you ever heard the phrase, “To finish first, first you must finish”? That’s very true in investing. If you blow up your portfolio, it’s game over.
How do we control risk?
We’ve already talked about the Margin of Safety, which is our number one risk control measure.
By buying at a discount to intrinsic value, market forces make it very unlikely to drive the prices significantly lower.
Our second risk control measure is to buy only strong established companies that have deep and wide moats in place. Why?
Because a company with all that is very unlikely to face a permanent decline in market value. Declines in things types of companies are usually tragically short. They always go back up before I’m done buying them.
Following these two rules alone will keep you out of most investments that are responsible for permanent loss of capital.
You won’t be buying stocks that lose money. You won’t be speculating. You won’t be buying into companies with stupid amounts of debt.
Second Order Thinking
Marks points out that the average investor is just that… average. To be better than average, you must have some sort of insight that the average investor lacks.
He says that often, what is lacking is ‘second-order thinking.’
What’s that?
Most people have no problem with cause-and-effect relationships. But second-order thinking takes into account the effects of the effects.
As you gain experience you see this sort of first-order-thinking behavior all the time.
One of my favorite companies is part of a cyclical market. Earnings decline every few years and share prices fall.
That is first-order thinking. Investors say “Earnings are falling, sell!”
But I also know that this company is continuing to gain market share and that earnings will go back up, so why would I sell?
Instead, I buy more.
I see past the effects in front of me to the effect of the effect (people sell and I get to buy in cheap).
Marks says to think of the market as a pendulum. Many people see it swing one way, but forget that it will come back the other way eventually.
The Perfect is the Enemy of the Good
Not only is this excellent investing advice, but it’s also part of the cornerstone of our productivity system.
This is just good life advice.
And it echos back to Munger’s idea of focusing on avoiding bad outcomes.
We aren’t trying to get the absolute best returns possible. Why not?
Doing that causes you to start chasing returns. And then you start making stupid mistakes. You start worrying about what others are doing. And you start worrying about beating your old high score. You start trading in and out of positions.
Instead, you should be worried about controlling risk.
It’s far better to focus on fundamentals, to make the best purchase available, and let the compounding take over for the long term.
In investing it’s better to hit a string of base hits than it is to swing for a home run.
The Fundamentals Are Forever
The fundamental forces of market economics will not change.
Every so many years you start to hear that the market is different now. And investors should change their ways.
You’ll start to hear pundits talking about this industry or this sector breaking the rules. (Actually, no you won’t because you don’t listen to pundits anymore, right?)
“This time it’s different” has always been proven wrong. In the end, the fundamental market forces win the day. Stocks that are way out of line, come back to their intrinsic value.
Really this is just another form of emotionality. The nifty fifty stocks, the new economy stocks, the FAANG stocks… each is an example of some special group that is immune to the laws of economics.
But, as Marks would say, “Trees don’t grow to the sky and few things go to zero.” If it looks too good to be true…
It is.
Peter Lynch
Peter Lynch is the legendary investor that managed the Magellan for Fidelity during the highest return period of the fund’s history. Over the course of a decade, he compounded the fund by a whopping 29% per year.
But that’s not why he’s made our list.
He made our list because he put down his attitudes toward investing in clear and approachable language in his book One Up On Wall Street.
And more importantly, it made sense. All of his advice was real-world, pragmatic, and could be implemented by anyone.
Much of Lynch’s philosophy overlaps with the previous greatest investors in history (are you noticing a pattern here?), so we won’t recount it here.
What follows are the aspects of his style that are not explicitly mentioned above.
There Are Opportunities Everywhere
Lynch recommends keeping an open mind when it comes to which industries and companies to look at.
Avoid prejudice, bias, or preconceived notions you might have about an industry or sector. These are almost always emotion-based and have usually come from hearsay or other opinions.
The danger is that you might have heard some pundit or news story somewhere, long in the past, and then forgot about it. But the opinion you formed is still floating around your head.
In short, many of those preconceived notions are baseless and are preventing you from finding outstanding opportunities.
Here’s a personal example. I have long held the bias that physical retail is dead. (And that is a very hard bias for me to shake).
And for a very long time, I ignored any physical retail investment because ‘physical retail is dead, duh.
But that made me miss out on an opportunity for a small company that is a specialty retailer. They sell in a specific niche and, more importantly, have a unique sales structure and manufacturer contacts that allow them to earn far above-average returns on capital.
So here is this stellar business in a less-than-stellar arena; physical retail. But they found a way to claw out a market share and they are rocking it.
In the end, I did end up buying a good chunk of stock, but I paid twice what I could have.
That means my biases cost me a 100% return.
So keep an open mind and remember that an outstanding business can shine in just about any environment.
When to Sell Your Stocks
We tend to agree with Buffett and Munger that the best holding period for a fabulous company is ‘forever’.
But in the real world, companies don’t always stay fabulous.
What do you then?
Lynch recommends writing down the reasons you chose the stock when you entered the position. Keep this info in a safe place. It could be years before you need it again. Keep a journal of your trades.
(In fact, according to a McKinsey & Co study, 66% of companies that have returns on capital above 20% will still have high returns 10 years later)
The idea is that if you’ve seen returns on capital drifting lower over the last few years, it might be time to pull out that trade journal.
Then see if the qualities you liked back then are still present today.
If yes, then hold on. If no, it’s time to let go.
Think about it this way: If you bought it because of A, B, and C…. but now it’s got X, Y, and Z… is it even the same company you bought?
Second: 7 Ways To Invest Like The Best Investors In History
So now we have our list of mentors we’ll never meet. And we know how they approached problems and thought about the market and investments.
Now what?
Now we start to put those principles into action. And we do that by distilling those tenets into actual actionable advice that we build into our routine.
Here at 3MM, we are all about routine. We want to make as few decisions as possible. That way we have lots of mental energy ready for the really big decisions that come along (like, say, a fabulous investment opportunity).
By the way, if you want to learn more about how we prioritize and create hyper-efficient operational systems check out our Productivity Guide
So here’s what we will do. We’re going to group all that wisdom into seven silos of investing wisdom.
Each silo will be clear, concrete, and actionable. You are either doing these or not. There is no wishy-washy advice here.
Investing Silo #1: Buy Businesses
When you buy a stock, you are buying a part ownership in the whole business, not just a piece of paper.
That’s why you want to have good and honest management.
And that’s why you want moats that can’t be crossed.
That’s why you need to make your investment decisions exactly the same way you make your business decisions.
Investing Silo #2: Seek Value
When we buy an investment, we want to get more value than we pay for. This increase both our return on investment and our margin of safety.
That’s why we want to pay less than intrinsic value.
And this helps us keep an eye on our opportunity costs. If I see two equally fine companies, but I can buy only one, I will choose the one that is furthest below intrinsic value.
Investing Silo #3: Think Rationally
Use math, not emotions. Be acutely aware of when emotions begin to creep in.
And they will creep in.
Whenever a problem arises, use inversion if you can. Remember it is better to avoid bad outcomes than to chase great ones.
Pay attention to compound annual growth rates (and learn how to calculate them). Most of my investment decisions are made easily because there is just no chance of them meeting my CAGR requirements.
I say no to almost everything.
Investing Silo #4: Think Independently
Filter out all news, pundits, opinions, and prejudices.
Allow only vetted, established, and respected sources of information. Even then, stay away from opinions.
By that I mean, stick to sources that talk about the nature of businesses or industries but aren’t trying to make predictions or convince you of something specific.
Know where your circle of competence lies, and where its edges are. Be honest with yourself about what you don’t know.
This circles back to avoiding bad decisions. You’ll do better than most just by staying true to what you know well.
Investing Silo #5: Never Stop Learning
Once you have accepted the fact that you need to stay within your circle of competence, you realize how important it is to constantly expand your circle.
Read and learn from as many different subjects and disciplines as possible. Remember Munger’s injunction to maintain a high level of multi-disciplinary mental models.
The trick is to make investing the linchpin of your cognitive life. Then, as you learn new things or gain new experiences, tie everything back to your linchpin.
Ask yourself: how can this new information help me become a better investor?
Get in this habit and you will have some profound insights. I recently had an epiphany about a company because of an article I read comparing apple orchards to wheat fields.
Seriously.
Investing Silo #6: Weather the Storms
Here’s a market prediction that will certainly come true: Markets are going to fall in the future.
Downturns are inevitable. The best thing you can do is to mentally prepare yourself for them before they happen.
How do you do that?
Well thinking rationally (focusing on numbers, not emotions) is a great start.
So is thinking independently. It helps prevent the doom-and-gloom contagion from taking hold.
Also, remember Mr. Market. A falling stock market is not a time to panic. It is just your unstable business partner finally offering you some excellent prices on his shares.
And when you start hearing people saying “this time it’s different”, that might just be the best time to start buying. Because the fundamentals never change.
Bonus: For me personally, the single best cure for the falling market panic is the concept of Look-Through Earnings. They really need their own post, in short, they work like this:
I track all the earnings that are attributable to my ownership and focus on increasing that dollar amount, not the actual price of the shares. I only pay attention to the price when shares look cheap and I want to pay more. Otherwise, as long as my look-through earnings are growing at a healthy clip, I’m happy, regardless of what the market is doing.
Investing Silo #7: Stay Positive
Keeping an open mind and a positive mindset are the best ways to uncover opportunities.
Remember what Peter Lynch said, Opportunity is everywhere.
Use your second-order thinking skills to see past the negativity so often at hand and find the silver lining that others miss.
And go easy on yourself. You’ll mess up. But if you follow these investment tactics, you won’t mess up that badly.
Perfection is the enemy of the good, after all. Give yourself permission to best less than perfect.
Third: Some Bonus Skills That Have Helped Us Invest Like The Best
Learn how to read financial statements.
Financial statements provide a snapshot of a company’s performance at a particular point in time. They show what happened during the past year and where the company stands now. Understanding the numbers helps you make better investment decisions.
There are two main parts of these reports you want to know well.
The financial statements, and the Management’s Discussion and Analysis.
Learning to read financial statements gives you a candid look into the health of the company.
Management’s Discussions give you an overview of the business and competitive landscape. (reading several years’ worth of these give you a sense of how capable and trustworthy management is)
Be patient.
There are plenty of online tools that will help you analyze companies and find out what makes them tick.
Once you’ve found a company you think has good prospects, you should start by reading its annual report. This document will give you insight into how the company operates and what it plans to do in the future. It also gives you a sense of whether the company is worth buying.
This takes time. And it can be frustrating.
I would guess that I say ‘no’ to more than 90% of the investments I consider. In high-flying markets, I’ve gone whole years without finding a good deal.
And then when you do finally make a purchase, it can take months or years to see any increase in price.
Patience is a virtue at either end of this investment process.
Don’t try to time the market.
Timing the market is one of the biggest mistakes people make when investing.
While there are certainly times when the stock market goes up, it’s not possible to predict exactly when those times will occur.
Instead, focus on finding a company with solid fundamentals and then stick with it.
No one can predict the future, and if someone says they can, it is time to run, not walk, away.
Closing Thoughts
We think of this as our investing pedigree. This is where our model was born.
And we’ve used that model to beat the market over the last 6 years.
Our goal here at Three Month Millionaire is to help you achieve freedom, both financially and in your working life. The dream is to build a million-dollar business that can be run in three months or less per year.
The cornerstone of that dream is a rational, systematic investment system that you have read about here.
To learn more about what we do here and how to achieve the 3MM dream, check out:
- Our Ultimate Guide to Building a Business
- Our Ultimate Productivity Guide
- Our Ultimate Guide to Investing
- Our Income Reports
We also publish unbiased reviews of business tools and software. To see some of our top review posts, Check out:
- Our reviews of the Best Online Course Creation Software
- Our reviews of the Best Books For Following the Three-Month Millionaire Journey
- Our reviews of the Best Business Tools No One Ever Told Us About
- Our reviews of the Best Social Media Management Tools
