The definition of a successful investment is to pay a price for an asset whose value subsequently increases significantly.
This is the aim of all investors (players).
The game is played continuously and the market provides a variable price which reflects the overall real time perception of an asset value in the moment. It matches a buyer with a seller, transactions taking place when both accept a price (to sell and buy).
A question everyone seeks to answer is how and why can a few investors (players) continually make strong returns when the majority don’t?
What’s their edge?
The answer must logically be that those successful few understand how to analyse and act on information in ways that the unsuccessful don’t.
It then follows that the normal or average methods employed by the majority don’t by definition actually work that well, because for there to be winners there must also be losers.
In essence, the ‘why’ must be a better process; they do it in a way that repeatably works and most people don’t.
The ‘how’ has been the subject of numerous books and involves a multitude of differentiators but fundamentally, the single element in common is the application of probabilistic mathematics over long enough time periods for the averages to assert.
The most successful investor of all time.
- The engine that powers his company Berkshire Hathaway is the insurance element
- The three keys to success in insurance are: (1) Underwriting risk at attractive rates of premium (i.e. applying the correct price to probable claims events) (2) Utilising the available float (float is the premiums paid which are held by the insurance company against future claims liability) by investing them to create profits. So investing the float funds in assets which have a high individual and a collective best certainty of rising in value over time (3)Do the above with consistency and discipline
Berkshire’s various operations over 4 decades have on average produced float at virtually no cost (meaning they have underwritten at a profit or broken even); this is highly unusual for the insurance industry.
The only question an investor needs to know over a longer term time horizon to consistently prosper is:
What is most likely to happen over the long term and what has the highest probability of success because of it?
This is fundamentally different to:
- What’s likely to happen next
- What could do very well next
- What’s going to have a tough time next
Whilst long term statistical analysis relies on the assimilation of multiple factors and maths, short term market timing relies far more on guess work and being lucky.
The coin toss and the casino
There are so many elements that can be analysed to explain the multi-level mental maps constructed by the finest investors, but two simple analogies can illustrate their base concept.
If a coin is tossed ten thousand times the high probability is that half the flips will be ‘heads’ and half ‘tails’ so there’s no advantage to betting on either in aggregate; this in essence is an efficient market theory, the information is known, nobody has an edge.
Whilst this is absolutely true within the ten thousand flips there will be periods when far more tails come up than heads, it can feel to many at this time that tails has an edge.
Mathematically, even if twenty tails have come up consecutively, the odds of a twenty first tail is still 50/50; each and every toss is 50/50.
However the probability of flipping 21 tails in a row is certainly not 50/50, that’s a statistical outlier for sure. Often people can mistake the longer term probability with the probability of what will happen next.
Now if one equates the above situation to a market in general the reaction of many to the 20 tails scenario is to jump aboard the winning train, tails never fails. It will be argued that success does not diminish future prospects because the statistical chances on the next toss have not worsened.
The reality however is that:
- The statistical likelihood of more heads in the future is much higher because parity will reassert over longer timeframes
- It is far cheaper to buy heads when everyone is loving the tails, this is a basic flaw in the inefficient market theory, it discounts the influence of human emotion and emotions are not grounded in logic and probability (it’s partly why people smoke or get married even though the chances of a bad outcome are high)
So simply, the optimum time to invest in an asset is when the market incorrectly undervalues its future prospects and as much as is ever possible the near certainty of a positive occurrence.
The games offered to gamblers are predicated on random chance with no way of anyone knowing what will happen next.
The casino knows that over time the odds are in its favour; that gamblers in aggregate can’t win.
It knows that individuals will win over short periods and actually that is important and desirable as it gives the illusion that the casino can be beaten but in reality it can’t.
The only way to beat the casino (market) is to card count, to use the flow of information of what cards have come out already to be able to calculate the constantly revising odds of the probability of what cards are left and whether that makes the odds favourable or not.
This practice changes the probability of success and is therefore not allowed by a casino because then they will lose.
The very best investors have realised that whilst casinos don’t allow card counting, markets in effect do.
They have worked out that if they are highly disciplined and watch multiple hands (share price moves) being played over long periods there will be a few situations where the statistical probability hugely favours them, at these times and these times only do they put down their chips because it’s mathematically sensible to do so.
This does not mean every hand (share purchase) will be a winner but it does mean that they have turned themselves from gambler into casino owner.
NOTE: This is written in a personal capacity and reflects the view of the author. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. This is not a recommendation to buy any product or service including any share or fund mentioned. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.