Good investors have style. That is, they have a style. Like most things in life, you do best at something if you figure out a way that works for you and then you focus your energies on getting really, really dialed into that one thing. One's investment style is what governs the choice to get into or out of any particular investment or asset class.
There are growth investors and momentum investors and value investors and on down the line. After spending the better part of 25 years watching all these styles, it strikes me that there is really only one style that will win the game and produce satisfying results consistently. That style involves the invocation of two simple rules:
- If something can't go on forever, it won't.
- If something is inevitable, it will happen.
There you have it: A graduate course in investment decision-making. If you take these two thoughts and turn them around in your head for a bit, you arrive at some interesting implications. Take the basic premise of "value-investing"— Warren Buffet style. The value investor says that if an asset is too cheap, it is inevitable that its price will rise to match its true value. The value investor also knows that if an asset's price has risen to irrationally exuberant levels, it will not continue to rise forever.
Another implication of these rules is that they say nothing of timing. While we know that cheap assets will rebound, we have no idea how long that might take. The single greatest mistake investors make is to try and get the timing too precise. If you think you will make money by timing peaks and valleys, you are in for a rough ride. The wise investor simply decides that some assets are too expensive and gets out; she decides that some assets are too cheap and gets in. Then, she is patient. The wise investor is not an owl, who goes hunting for prey. She is a vulture, who sits and waits. And waits.
Real estate values are falling. Can they fall forever? Of course not. When they get cheap enough, we buy real estate. Might values keep falling? Sure. The wise investor who uses value principles must be willing to be wrong for stretches of time. No worries—values can't fall forever. So long as we avoid using leverage to make our investments, we needn't worry about short-term moves against us.
These two rules are the backbone of the concept that investment prices are mean-reverting. The true fair value of an investment is often unknown, but it is like the dark matter out in the cosmos that so mystifies astronomers. We can't see it. We don't even know what it is. But we do know with certainty that it is attracting all things toward it, like a cosmic tugboat. Fair value is like gravity; it pulls asset prices inexorably up or down, as the case may be. All we need to do as wise investors is to recognize this law of nature and position our portfolios on the right side of the cosmic tug.
–Rick Ashburn, CFA, is Chief Investment Officer of Creekside Partners Investment Counsel in Lafayette, California. He has managed investments for institutional and private clients for 23 years. Visit his website at creeksidepartners.com [1], or e-mail him at rick [at] creeksidepartners [dot] com.