investing

Debunking Investing Myths

I told Rick Barry I’d rather shoot 0% than shoot underhand. I’m too cool for that.

Myth #1: Quants, sophisticated algorithms, and the brightest minds in the world struggle to beat the market, and most do not. The odds are that Sam from Nebraska will not outperform the market and is better off not playing around with individual stocks. Just invest in index funds.

The problem you have, and will continue to see, is the word “invest” being interchangeably used with trading, gambling, speculating, etc…

Not everyone buying stocks is investing, certainly not long-term investing.

Many fund managers or professionals you read about do not even invest in their own fund.

Why would you invest in a fund if the fund manager isn’t doing the same?

Wall Street’s strategies differ from what you should mimic.

Investors need to understand the fundamental difference between generating income and building wealth. Typically, stocks are a wealth-building tool. Generating income from stocks requires more short-term thinking and trading strategies. 

The more I see investors tinker with their portfolios or trade in and out of positions, the more confused I become. Price movement in the short term is often volatile and unpredictable. It also can be stressful and gut-wrenching. Emulating Jesse Livermore or Steve Cohen is more challenging than being the next Ronald Read or Geoffrey Holt.

As for index funds, the fundamental problem with this instrument is that it is a self-defeating investing practice. You have chosen to match the market rather than outperform it. The technical framework of most index funds is capping your gains by taking on less risk. This investment vehicle may suit some people, but I find it unacceptable.

Investing in index funds that follow a benchmark may be suitable for those who can generate a lot of income or have multiple income streams. It also may work if your portfolio is already large enough to live off without supplemental income.

You get what you deserve: The equity investor is entitled to a bigger reward because they took on more risk. Investing primarily in an index also does not change behavior or protect investors from the psychology of investing. Remember, future returns are not guaranteed. Index investing is popular because it has done well historically. Once again, a 10-15% average annual return is not guaranteed, and there is no way to assess the probability of future annual returns with pinpoint accuracy.

“A really wonderful business is very well protected against the vicissitudes of the economy over time and competition. I mean, we’re talking about businesses that are resistant to effective competition…”

“There is less risk in owning three easy-to-identify wonderful businesses than there is in owning 50 well-known, big businesses.”

– Warren Buffett

I never understood the attraction to wanting to own the entire market. It insulates yourself against a particular risk, but this diversification is unnecessary and can show a lack of focus and conviction.

Owning ten or more index funds or ETFs in your portfolios is “analysis paralysis” on steroids. There likely is a lot of overlap and bloat.

An investor must ask themselves, “What is the bigger picture?”

Diversification could help against risk, but over-diversification will likely hurt performance.

  • Diluted returns: Being right on a particular holding in a fund or index won’t make a material difference. The percentage of your portfolio is too insignificant to make a meaningful move.
  • Unnecessary risk protection: Some companies have a market cap equal to greater than the GDP of a small country. Not wanting to own these companies individually due to their potential to go to zero is not the best way to assess probability and risk.
  • The Brock Purdy/Tom Brady effect: The 49ers got lucky when they drafted Brock Purdy in round 7, pick #262. The Patriots got lucky when they drafted Tom Brady in round 6, pick #199. If these teams were confident that these quarterbacks would turn out the way they did, they would have drafted them in much earlier rounds. These teams took a small risk that paid off handsomely. Investing has similar scenarios. Investing $5,000 isn’t a lot of skin-in-game or conviction. A $5,000 investment in Microsoft in the 90s would be well over one million dollars today – and guess what? Microsoft is, by many analysts, rated a must-own stock today! These types of gains you will never see solely investing in an index.

Myth #2: I would have to spend countless hours researching individual companies and monitoring the market daily. Why invest in stocks with the odds out of favor in beating the S&P and its proven returns?

As I explained earlier, investors who primarily invest in an index are entitled to a lower return than a direct equity shareholder in companies who take on more risk.

The research barrier people make not to invest has always perplexed me. Looking at a company’s balance sheet is a relatively simple exercise. Earning reports are quarterly events and typically get recapped in a 1-page article.

Should an investor pay attention to current events and occasionally read business news? Everyone should be doing this, but is it necessary to spend several hours a day of research to be a successful investor?

Monitoring the market is a behavioral choice, not a requirement of being an investor. If you are a long-term investor and have already committed to holding a stock for an extended period, watching the price movement of a ticker symbol every day or every hour is an addictive habit that doesn’t help advance your investing skills. A company’s fundamentals do not change daily, even monthly, so worrying about daily price fluctuation is an unnecessary risk of losing your sanity.

No one can accurately predict the future. Every investment is a bet. You will likely succeed if you have a consistent framework for investment decisions and can understand the basic plumbing of how a company makes a profit. In most cases, the research advantage is not a true advantage. There is no significant correlation between time spent researching investments and investor performance.

Investor A: Invested $100,000 in Apple Stock in 2007 due to how innovative the iPhone looked during its launch.

Investor B: Invested $100,000 in Apple Stock in 2007 after doing hours and months of research in the company, reading balance sheets, plugging numbers through several financial modeling tools, reading articles, etc.

Investor B has more formal education than Investor A. Most people would consider Investor B “smarter” than Investor A. Investor B is an extremely hard worker, shrewd at business, and knowledgeable about the stock market.

The result is the same if both investors sell at the same time. Investor B may have been likelier to sell the stock, trying to time the market by mistaking research for market noise. For a long-term investor, selling Apple stock in the past 15 years would have been a mistake, even if the reason was valid.

Putting hours of research into investments doesn’t give you a guaranteed edge in investing. Having high cognitive intelligence doesn’t correlate to investing performance. 

Investing does not require you to write a 200-page dissertation to be successful. “Time in the market” refers to the holding period, not time spent researching.

Being a highly-rated brain surgeon requires years of studying and training. The same goes for being a world-class athlete or chef.

Investing is a rare activity where sitting on your ass and doing nothing pays off more than trading in-and-out of stocks. The investor’s hidden superpower comes from having discipline, patience, and emotional intelligence. The stock market is auction-driven, where you cannot drive the outcome of the results outside of buying, holding, or selling a stock.

The skillset required is a behavioral one. That is the secret weapon needed to beat the market. In all likelihood, investors A and B have already sold their positions in Apple stock for various reasons.

“On the other hand, although I have a regular work schedule, I take time to go for long walks on the beach so that I can listen to what is going on inside my head. If my work isn’t going well, I lie down in the middle of a workday and gaze at the ceiling while I listen and visualize what goes on in my imagination.”

-Albert Einstein

The problem with the research argument:

  • Investors must understand that this game of critical thinking. Being an investor is a thought-job. Success comes from curiosity and continuous thought work.
  • Research/Investing is subjective. One person can determine Bitcoin as ‘rat poison,’ and another person can evaluate it as the future of money.
  • Investment returns directly correlate with how much risk you are willing to take, not how many hours of research you have done. No matter how much research an investor does, it cannot accurately predict future prices or events.

Myth #3: Pick the right company takes a lot of work. It is simply too risky, and the odds are not in your favor.

It is an easily debunked myth because the proof is an investor’s brokerage statement. Many professional and retail investors correctly invested early in companies like Nvidia, Apple, Amazon, and Tesla. These investors correctly picked the right company that generates life-changing results. These companies are well-known and have recognizable brands.

The problem is that most of these investors sold out too soon, indicating poor investment behavior. Investors frequently let fear and other emotions guide their strategic investment process.

Many investors also incorporate too much of a “market timing” tactical approach in their investment strategy, leading to how powerful psychological forces play into investing decisions. If the secret to wealth building is to buy and hold companies like Apple and Nvidia for a long time, why do so many people refuse to do so?

The answer is complex and simple at the same time. It would be like asking why don’t all poor free throw shooters in the NBA use the ‘Granny Shot’ free throw motion, where the player holds the ball at his waist with both hands and hoists the ball at the hoop in an underhand motion, with arms spread apart.

There is actual evidence that the Granny-style form works:

One argument in favour of shooting underhand, compared with traditional overhand, is that it requires less movement and is therefore easier to repeat. There are physics behind the form as well. Shooting underhand creates a slower, softer shot, because a two-hand shot, gripped from the sides of the ball, allows a player to impart more spin than a shooter launching the ball forward with one hand.

John Fontanella, a professor at the Naval Academy who wrote “The Physics of Basketball,” said most shots spin at two revolutions per second, but an underhand free throw will rotate three or four times per second. The additional backspin means more shots that bounce on the rim fall through.

NBA rookie brings back ‘Granny-style’ free throw

Shaq attempted 13,569 free throws in the regular season and playoffs for his career. He made 7,103, just 52.3%, which is pathetic.

If Shaq worked on and adopted the granny shot the day he started the NBA, say, his career free throw percentage would improve to 70%. That’s 2,395 more points. How many more games and championships does Shaq win by doing this?

Despite the empirical and analytical evidence, no NBA star has adopted this shooting style since 1980. 

Why? The answers players give are silly:

Shaq: “I’d shoot zero percent before I’d shoot underhanded.”

“They’re gonna make fun of me.” 

“That’s a shot for sissies.”

The reasons why most poor free throw shooters don’t adopt a technique that is proven to work are similar to the same reasons why most investors can’t buy and hold stocks for a long time:

Fear of standing out

Outside of your comfort zone

Pride and ego 

Herd mentality

Many investors invest like Shaq shoots free throws. 

Shaq didn’t want to shoot underhanded because it wasn’t for him, even though it would have dramatically helped his free throw percentage.

People want to invest successfully, but they want to do it on their own terms. The rewards are life-changing, but it requires you to embrace chaos and uncertainty. Outside of your emotions, an investor has no control over the economy or geopolitics. For many investors, long-term investing means: “If I make money, I’ll stick with it, and if I don’t, I’ll sell and do something else.”

The most significant risk factor for investors is themselves.

It is not the economy, interest rates, or the threat of war. The biggest threat to your portfolio is your behavior.

My advice:

  • Do not get too cute with your overall portfolio strategy.
  • Stay focused and adopt long-termism.
  • If you have the discipline, adopt something similar to the coffee can strategy, an investing strategy where you mostly stay still during market volatility and sell recommendations.

Do not sell winners like Nvidia or Apple simply because someone says it is time to sell. These are companies you buy and hold, not trade. Selling a stock because someone said it’s wise to trim your position has been dud advice for high-quality companies. Keep asking yourself, “What is the bigger picture?”

People managing funds are investors at heart. They research solid companies in attractive industries that can grow from a long-term perspective. But they inevitably engage in profit-taking and market-timing based on news/rumors, drastically shortening the time horizon. We then become hyper-influenced by analysts’ recommendations and hyper-fixated on valuation metrics. Long-term investing involves holding during downturns, but letting your winners run is equally important.

Investing and Wegovy

Before ending the year, I wanted to discuss why investing is so difficult for many of us.

Investing is complex because several factors influence our decision-making and behavior. Some factors are within our control, and others are not. If you believe investing is only about math and financial modeling, you will likely struggle as a long-term investor. Investing is unique because it is a science and an art. It requires more than just analytics. There is a behavioral and psychological side that is much harder to measure.

Long-term investing: Much of what you’re willing to endure and risk to achieve a reward.

Investing behavior and decision-making are rarely caused by a single factor. There is an interplay of various influences that determines your risk tolerance and expectations. The better you understand these factors, the more likely you are to develop effective strategies to improve your performance.

When you think about successful investing, compare it to dieting and exercise. There are no shortcuts or one-size-fits-all answers. Generic solutions often become platitudes. Advice like weight is calorie-in-calorie-out, becomes a platitude. Someone morbidly obese could have the same diet as a marathon runner; the results may not be the same. Several key factors contribute to a healthy lifestyle. The same goes for investing. A financial expert who tells you the best way to support is to “index fund and chill” is oversimplifying a solution that doesn’t work for everyone.

Generally, people need to be motivated to lose weight. It is challenging to feel motivated if they do not see short-term results or if it takes too much time and energy to maintain a diet. Knowing vegetables and fruits are good for you doesn’t necessarily lead to a change in action. Understanding that you need to do more cardiovascular activities doesn’t mean you will start running daily. Without goals or action plans, you will get situations where people want to eat healthier but do not make meaningful changes in their diet or exercise.

Improving your outcome relates to your behavior. How do you change your behavior? Create goals to help develop your strategy. The more personal your goals become, the more likely you are to become motivated to achieve them.

Why invest:

  • Buy more material things.
  • Buy more experiences or influence.
  • Be able to support your spouse or family.
  • Fund your retirement.
  • Pass along your wealth to your children.

Why lose weight and exercise:

  • Improve external appearance.
  • Feel better physically and mentally.
  • Not be bedridden later in your life.
  • Be there for your loved ones.
  • Live a longer and more fulfilling life.

Investing is a mixture of science and human behavior. Human behavior is very imperfect, different, and subjective. Your behavior needs to change to see different results.

Financial experts say the best way to invest is through ETFs or index-weighted funds. Such advice is generic and does not change your behavioral psychology. It does not change the bad habit of consistently buying overvalued assets and selling them at a much lower valuation.

What happens when the index you invested in, based on the advice of experts, is down 10% or more?

Do you sell?

What if, after ten years, your portfolio is flat? Did you even plan on having a holding period that long?

  • If you are a long-term investor but continuously trade in and out of stocks.
  • If you enjoy highly volatile growth companies but have little tolerance for risk.

  • If you are health conscious, but your diet consists of fried food and sugary drinks.
  • If you spend a lot of money on athletic clothes but do not work out

Your actions do not align with your goals.

Align your goals and timeframe with your actions; the outcome should improve.

The problem with professional investing:

Most people can agree long-term investing works, and allowing high-quality companies to grow and compound requires a long-term holding period. So then, why is the average holding period of an individual stock just 6-10 months?

Professional fund managers: A profession where their income depends on quarterly performance. Income comes mainly from fees charged to investors who invest in them.

Funds flow out of underperforming funds and into those performing best, creating a casino environment where most fund managers chase gains and trade in and out of positions. Institutional fund managers’ informational and analytical edge over retail investors is almost useless, as they act more like traders than investors.

Institutional and Retail investors: Actions and goals not aligned with long-term performance.  

Retail Investors: Freedom to invest without restrictions or deadlines. The behavioral edge often goes unrealized as retail falls victim to the same pitfalls as institutions – panic selling, over-trading, chasing gains/momentum, and emotional decision-making.

It is not your fault:

If you are struggling as an investor, it is not your fault. If you are struggling with losing weight, it is not your fault.

In 1942, the Metropolitan Life Insurance Company made standard tables to identify ‘ideal’ (and later ‘desirable’) weight, and with the naming of weight-to-height ratios as the body mass index (BMI) by Keys and colleagues in 1972, obesity was understood as a health risk that required medical intervention. 

The politics of disease: Obesity in historical perspective

It has taken a while, but society is starting to accept that genetics, medical conditions, and other factors that contribute to our weight are outside an individual’s control. The American Medical Association (AMA) recognized obesity as a disease in 2013!

Labeling obesity as a disease is helpful as it takes pressure off the patient, not putting the blame all on themselves.

The same goes for investing. Human nature works against good investing. There is a tremendous fear of non-guarantees and a need for certainty. Human nature can work against us when it comes to investing. How does it feel to bungee jump 700 feet above the ground? You can only understand the feeling once it happens, just like how you will feel and respond to watching your portfolio fall 20% in a week. For most people, it’s likely a combination of fear, depression, and panic.

If lousy investing habits and obesity aren’t your fault entirely, how do you fix it?

The answer:

Every patient is different.

Every investor is different.

Each requires personalized attention and solutions.

I hate the phrase, “It isn’t your fault,” because even if true, what now? It does not give people the mindset that they have the power or control to change their circumstances.

Genetics, human nature, and upbringing play a role, but we are all not destined to be victims of circumstance. It is within our control over what’s preventing the desired outcome – Maintaining a healthy weight or having enough for retirement.

With the proper motivation and mindset, behavior can change gradually. There are no quick fixes.

Can GLP-1s like Wegovy or Ozempic help with weight loss? It could be part of the solution but only part of the solution. Medication does not replace a healthy lifestyle, what you eat, or daily exercise. Anyone struggling with weight should consult an endocrinologist and obesity medicine physician to develop a beneficial outcome.

Investing does not have one-size-fits-all solutions. Depending on your circumstances and financial goals, investing in funds that track broad-based indexes can help a portfolio. Should you consult a financial advisor? If that person can take the time to understand your needs based on your situation, it could help. Any effective solutions need to be customizable according to individual needs. As an investor, your primary objective should be to obtain greater knowledge and, as a result, steer you to more control over your finances.

Invest in Meghan Markle Stocks

According to royal expert Katie Nicholl, King Charles reportedly nicknamed his daughter-in-law Meghan Markle ‘Tungsten’ because of her toughness and resilience. The Oxford English Dictionary defines tungsten as the chemical element of atomic number 74, a hard steel-gray metal of the transition series. It has a very high melting point (3410°C) and is used to make electric light filaments.

Being nicknamed after a rugged metal seems peculiar, but Meghan Markle, Duchess of Sussex, seems like someone with a strong backbone who gets what she wants. Meghan is opportunistic and cunning. Although these may seem like critiques of her personality, they complement her inner strength. Companies with tungsten-like qualities can turn into fantastic growth stocks to invest in.

Here is a list of some companies I would qualify as a Meghan Markle stock:

Alphabet
Shopify
Nvidia
Chipotle
Revolve
Airbnb
Taiwan Semiconductor
Zoom Video
Pinterest
Palantir
Moderna
Intuitive Surgical
Duolingo
Monday.com
The Trade Desk

So, what characteristics do I look for in a Meghan Markle stock?

Companies that have significantly more cash than debt: A company with more debt than cash is not necessarily a bad business – see Live Nation, Netflix, and Uber, as their debt is in use for future growth, but this does create higher risk, especially if a companies revenue plummets. Blue Chip companies like Apple and Berkshire Hathaway are in a separate category. They can safely take on debt for strategic reasons due to their strong balance sheets, track record, and business models.

Investing in the company’s future growth could pay off tenfold (Amazon investing in AWS) or backfire (Peloton expanding showrooms and acquiring Precor during the pandemic). Companies with more debt than cash risk serious liquidity issues, which may further dilute shareholders through equity raises or breaching a loan covenant.

A couple of companies that are NOT Meghan Markle stocks are Carnival Cruise and Royal Caribbean Group. We know why they took on significant loans, and although the pandemic was not their fault, they are far less attractive now than before 2020. These companies have recovered and are seeing healthy booking demand, but it will take several years (if not more) to right their financial health. The increased debt limits their options and leaves them with less wiggle room if the economy were to turn.

Low Capex and G&A ratios: Lower Capex and G&A spending can lead to higher free cash flow and a better return on capital. Relatively low costs for assets like factories or equipment mean the company can focus on capturing more market share and expanding into international markets. For tech companies, you want them to spend heavily on R&D rather than on upgrading stores. For apparel brands, you want them to spend heavily on S&M to build up their brand rather than on office furniture because when Capex and G&A make up a meaningful percentage of a company’s net income, that could indicate excess spending. If profit margins are increasing faster than Capex, that’s typically a sign of healthy financial growth.

Market cap higher than their Enterprise value: This characteristic echoes a company having more cash than debt. Companies like these have a low probability of going into bankruptcy and are attractive acquisition targets. Companies sitting on a lot of cash and little debt are typically more nimble and opportunistic. They can wait for the right time to issue share buybacks, reinvest in their business, make acquisitions, or be acquired themselves.

Proven more than two or more consecutive years or eight straight quarters of being free cash flow positive: A solid growth company has to prove it can be profitable in the long term. Being free cash negative is not a long-term sustainable business model. At some point, there needs to be a long enough track record of consistent growth; if not, the investment is just a speculative bet. If free cash flow exceeds net income every quarter, that could signify a money-printing business. Yelp has always been free cash flow positive since being a public company. The business may not seem appetizing, but its performance and return to investors have been much better than the companies that get the most airtime on CNBC and Bloomberg.

Important things to consider:

Asset light does not equate to a moat: Amazon is more debt-intensive than other big tech companies, which has helped them create a durable moat. How many companies will outspend Amazon to build a better logistics network? The same goes for Uber and its global ridesharing network. Debt and high spending can help a company have true pricing power, so there are potential trade-offs when a company sacrifices immediate profits for future growth.

Rising Free Cash Flow drives growth: A company that can produce consistently growing free cash flow is worth looking into, even if it has increased expenses, debt, or equity dilution. Apple is miraculous as they have higher free cash flow than most other companies, bringing in total revenue! They are more of an anomaly as they have so much cash and can increase their dividend while buying back their shares simultaneously.

Industry matters: Certain industries, like e-commerce, have more competition. Getting market share can be difficult during a challenging macro, creating a cash burn. The lower the startup costs, the easier for new entrants to disrupt the market. Specific sectors in technology are volatile, so a pristine balance sheet may reflect little returns for investors.

The critical aspects of these Meghan Markle stocks are toughness and resilience. Consumer headwinds can persist for several quarters, and if these companies remain profitable during a touch macro, that is a good sign of long-term durability. Like cockroaches, a company with low debt, consistently rising revenue, and free cash flow is almost impossible to squish. A company’s financials are easily accessible on a balance sheet, and any investor should know these basic figures to establish a framework of understanding before making a more thorough analysis and deep dive.