You don?t have to get all or even most of your initial investments right to make money as an investor
When you look at your portfolio, what do you see? Is your eye drawn to the glaring red of that dud investment ? the big minus that reminds you that, like every investor, you sometimes get it wrong.
In my case, the bleeding wound is Morrisons, bought for a yield that ended up being sacrificed on the altar of Aldi and Lidl.
Do I notice the doubling of BT since I bought it? Not really. The steady rise of WH Smith? No, it?s the 45pc drop in the supermarket share that I can?t take my eyes off. It?s my personal reminder that the pain of losing £100 is sharper than the joy of receiving the same amount. Investors are not rational.
So what did I do when Morrisons fell below my purchase price? You may not be surprised to read that I did nothing. It will bounce, I thought. The yield is even more attractive now, I rationalised. My capacity for self-delusion increased as the share price fell. I was transfixed, a rabbit in the headlights.
In The Art of Execution, a fantastic new book by Lee Freeman-Shor, the Rabbits are one of five categories of investor ? and the ones that come out with least credit. We rabbits commit the cardinal sin when a share price falls of doing nothing. One of the central messages of Freeman-Shor?s book is that doing nothing is not an option.
When an investment goes wrong, he says, you have two choices. You can be an Assassin, killing the investment dead as soon as it falls through a pre-determined stop-loss. Or you can be a Hunter, taking the opportunity to buy more.
Being an Assassin is not risk-free ? the reason investors hang on to a loser is often the fear of being whipsawed out of an ultimately winning investment. It happens, but not very often. Around two thirds of the time you are better off cutting your losses.
Being a Hunter, of course, is even more risky. You are doubling up, potentially compounding your initial error with the sin of arrogance. But when it works, it can turn a loser into a winner by reducing your average purchase price. Even if you never recover the original entry price you can end up making money.
But this approach requires courage. The kind of guts that saw Warren Buffett invest 42pc of Berkshire Hathaway?s assets in American Express in 1974 when no one else was interested.
The success of the Assassins and Hunters compared to the Rabbits is not just theoretical. What makes The Art of Execution such a compelling read is the fact that the data are real.
They reflect more than 30,000 trades made by 45 top investors employed by the author in his day job as a fund-of-funds manager at Old Mutual between 2006 and 2013.
His conclusion is striking. You don?t have to get all or even most of your initial investments right to make money as an investor. You don?t even have to get half of them right.
Freeman-Shor was shocked to discover when he analysed the performance of his hand-picked professional investors that only 49pc of their investments were profitable from first purchase to sale. Some of his A-team got only 30pc of their calls right. What mattered was how they behaved after their initial investment.
This was true when they got it right as much as when they got it wrong. One of the principal reasons why apparently indifferent investors made great long-term profits was that they did the psychologically difficult thing on the way up as well as the way down.
On the winning side of the trade, Freeman-Shor categorised his investors as Raiders or Connoisseurs. Raiders can?t resist the lure of the easy profit. Among the 30,000 trades in his fund, 42pc of profits were taken within three months and 61pc within half a year.
Only 2pc of profits were taken after a holding period of three years or more. Raiders are the trigger-happy alter-egos of the scared Rabbits.
The Connoisseurs are the investors who resist the urge to raid, holding on to a few massive winners for the long haul.
Many of them ease the pain of resisting instant gratification by selling small tranches of shares on the way up.
If it keeps you in the game, it?s an opportunity loss that?s well worth paying.
There is a handful of investment books I wish someone had given me 30 years ago. This is one of them.