Throughout many of the books I’ve read by successful investors there is one common tactic to the successful methods of different investors. This tactic is “rules based investing.” In passive investments such as indexing after developing a balanced portfolio based on the investor’s risk parameters rebalancing a portfolio annually to keep their balanced allocations in check is a rules based endeavor, and the data behind it shows it improves results. In value investing sticking to and using time tested evaluation rules is another form of rules based behavior. In my opinion, along with the skills and emotional aspects of investing there is a small presence of luck in investing, and when luck is present those that follow a disciplined rules based strategy usually allows that strategy to capture more wins than those that don’t.
Index investing uses a rules based approach by forming a diversified portfolio and then when the portfolio gets out of balance in one asset class over another the portfolio gets rebalanced back to normalcy. What this process does is it forces the investor to take money off the table in the asset classes that have done well and add to the portfolio in asset classes that are struggling. These actions rebalance the portfolio back to its original allocations. One of the hardest parts of investing is knowing when to take profits. By following this rules based approach of re-balancing it makes it easy for the passive investor to succeed in claiming wins. A study done by Longboard Asset Management revealed that over their lifetime 40% of stocks lose money, and that 64% of stocks under perform a broad based market index, and that only 25% of the stocks account for all of the gains in the market over time. With odds like this there has to be a method based on consistent rules that enables the investor to succeed over time, and in my opinion, the only way is with rules that systematically redistribute the gains into weakness until the weakness become gains and get re-balanced out again.
The great investors Warren Buffett and Charlie Munger who subscribe to value investing certainly have their rules which originate from the teachings of Benjamin Graham. Buffett and Munger have adapted Graham’s rules to work for their ways. Yet with Graham’s core at their usage Buffett and Munger have other rules they use of which many of us see written or hear about through the media. Rules like never lose money, or it’s better to buy a wonderful company at a fair price than a fair company at a wonderful price, or our holding period is forever are all rules that both of them follow. What you find within value investing is that many of the successful investors tend to all have rules based investment strategies that work for them.
When any fragment of luck is present it’s the ability to grab more luck than others and the only way this is possible is with disciplined rules that are consistently followed. As an example withIn real estate investing it’s those that have rules based discipline and practice their craft over and over that seem to find the best opportunities. In sports it’s the athlete’s that maintains a consistent disciplined rules based training approach that usually outperform their peers. If you do it more, more of the luck falls into your court, and you become better and knowing where to find the opportunities and capture them. Sure every once in a while every squirrel finds a nut, but as Charlie Munger says, the best way to catch fish is to go where the fish are, and it’s hard to know where the fish are if you aren’t practicing your craft all the time. It’s this same theory that rewards those that invest passively or actively.