Abnormal Returns, my favorite investing blog, had a piece yesterday entitled: Being right is overrated. It was a good post, but I felt I needed to take the other side of the argument, because I have heard this argument too much recently. Here is what I wrote:
I’m going to take the other side of this one. This is a bear/choppy market argument. During a sustained bull market, being right makes lots of money.
When I choose stocks, I do all that I can to have the odds tipped in my favor — industry analysis, earnings quality analysis, valuation analysis, balance sheet analysis, free cash flow use, and even a review of the anomalies like momentum, volatility, balance sheet growth, etc.
It’s not perfect, but I typically have 70% winners, and my winners are larger than my losers. Being right helps make money… does anyone doubt that? But hubris destroys.
Does that mean I give up my risk control disciplines? No. I get things wrong, and when I am wrong, I cut my losses. Every 20% move down requires a review — if the thesis is intact, I buy enough to rebalance. If not, I sell.
Also, my methods continually improve my portfolio, selling things with less potential to buy things with greater potential.
I’ll give you this — I knew a fellow for whom every position was a holy crusade. The regret level was high. He always wanted to win, and win big. Risk control took a back seat. If his staff had not been correct with a high level of frequency, his asset management firm would have died. As it was, they were constantly dealing with shorts running against them, with the pain of increase, cover some, go flat. Usually it went first increase, increase a little more, then cover some, some more, some more, until the momentum broke, and they would scale out with modest losses. And, the opposite with longs going down, but they wouldn’t rebalance like I do; they would double the position.
Toward money management of this sort, I would say, “Do you want to make money, or do you want to be proud?” Pride goeth before a fall (Pr 16:18). It’s fine to want to be right, and to aim for it, but it is wrong to not be modest, and realize that we will be wrong, and methods must be employed to limit losses when we are wrong.
Humility is an asset in all of life — it is even more so when it comes to asset management. Reckless, macho asset management tends to lose, while those that focus on “what could go wrong?” tend to win. Ben Graham’s main idea was not cheapness, it was margin of safety — we need to focus on safety more, and cheapness less.