Successful Investing? Be Normal
You don't have to be brilliant, only a little bit wiser than the other guys, on average, for a long, long time.
— Charlie Munger
Most people assume that to do well or get ahead in investing, you would need to be armed with proper information, trade quickly, and know what is happening 6 months into the future. All in an effort to get a step ahead of others.
Especially with what is happening at present; if a recession is coming, do you buy defensive stocks? What are the defensive sectors poised to ride out this current slowdown? Do you hold cash and wait? Do you seek the safety of bonds although 2022 was unique that bonds are almost down as much as stocks?
Actually, you don’t need to do any of these things. If you held a properly diversified investment across all investible asset classes, you would definitely turn out fine. You can get things wrong half the time; not knowing when the recession will come, and not knowing when to buy or sell, yet still make a fortune. Like what Charlie Munger said, you just need to be average and stick to it for a long time. Let’s take some examples from the art world.
Heinz Berggruen, a German-born Jewish art dealer was considered one of the most successful art dealers and collectors of all time. He was renowned as being one of Picasso’s close friends and a specialist in the works of other famous artists like Van Gogh, Cézanne, Matisse, Paul Klee, Hans Arp and Giacometti. Whilst Mr Berggruen was already well known for his eye for art, he became a celebrity a few years before his death when he sold a large chunk of his collection (worth $1.2B euros) back to the Berlin museum for a tenth of its value at $120 million euros. The Germans paid homage and held him in high regard for the fact that he sold the art at such an incredible discount, especially back to the country which he had fled for his life when the Nazis came to power.
How did he manage to amass such a large collection of valuable art? And how could he have predicted the rise of the artists - after all art is quite subjective. Most people would say that he was just born talented. Others may say that he was lucky. However, a study by Horizon Research Group showed that the success of such art collectors was actually much more “average” and very relevant to well-documented investing concepts.
According to the research team, the great art collectors bought vast quantities of art, of which a small number turned out to be great investments. These great investments were then held for sufficiently long periods and their value allowed to compound over time. So it turns out that to create a small fortune, you needed to be diversified and patient - two age old tenets of successful investing. Successful art dealers like Berggruen operated like evidence-based indexing. They bought a whole lot, held it for a very long time and rarely traded.
On average, they noted that art collectors held on to pieces for at least 25 years - something that bond or equity investors rarely do. The table below simplifies how an art investor was able to generate a return over that period.
Assume the person started with $1M. As the collector does not trade the art, 1/5 of the portfolio was left to compound at 25% returns, the other fifth at 15%, the next at 10%, another fifth gives no returns at 0% and the last fifth loses 10% every year. When summed up after the entire period, the collector made an annualised return of around 18% on the art.
Investing in stocks is nearly the same and stock returns have a similar return profile to the simple example above. Recent studies led by Hendrik Bessembinder from the Arizona State University, showed that stock returns were strongly positively skewed. What does that mean? He showed that only a handful of stocks provided all the gains in the stock market - with the vast majority not even matching up with short-term deposit rates.
Bessembinder, Hendrik (Hank) and Chen, Te-Feng and Choi, Goeun and Wei, Kuo-Chiang (John), Do Global Stocks Outperform US Treasury Bills? (July 5, 2019). Available at SSRN: https://ssrn.com/abstract=3415739 or http://dx.doi.org/10.2139/ssrn.3415739
The chart above shows the distribution for the sample taken from 1990 to 2018. Around 5 to 8% of the stocks gave you the punchy 10x returns. Another 10% gave you an average 2.5x return. A large 20% chunk doubled your money. The vast majority returned you back your capital or lost it.
We know that a diversified stock investment could get you around a 10% annualised return. So for a $1M investment over 25 years, you would end up with approximately $10.8M. A very simplified plot of the data from the research is shown in the table below:
Source: Bessembinder study and GYC estimates.
An investor who has $1M and invests in a diversified stock portfolio over the years would have around 10% of his money doing great, which drove almost all of his gains. The other 30% of the stocks gave so-so returns and a large chunk were wealth destroyers. However, investing in this manner gave the investor close to the long-term average return.
Much like the art collector who had a few pieces of his collection sell for extraordinary amounts of money, the stock investor had a portion of his portfolio grow an extraordinary amount.
Why is this relevant today? We always feel compelled to find that next company that can make us rich. We are always searching for that next Amazon or Apple that grows from $1 to $100. We also want to try to avoid that Enron, Kodak or in local context, Hyflux or Noble. However, the statistics shows that it is difficult. Very often it is less than a 1 in 10 chance - you may have better luck flipping a coin.
In investing, this happens very often - a small percentage of outcomes has an extremely large influence on the final result. The statistics of how many stocks do well means that you need to be lucky, not skillful in order to choose the right ones. But we would be able to capture the returns by just investing in everything and casting our net as wide as possible.
You don’t need to have extreme intelligence or skills to invest well. You just need to be normal.
