Free Capital

Free capital – a pot of money surplus to immediate living expenses – is the raw material with which the investors work.

Personal investing requires no deference, self-promotion, management skills or tact; it requires only a few good decisions.

an individualistic game loosely defined by rules which are sufficiently static to make experience valuable, but also sufficiently fluid to keep the game interesting.

Oscar Wilde’s maxim: “Man is least himself when he talks in his own person. Give him a mask, and he will tell you the truth.”

Geographers have a top-down focus starting from the overall investment landscape; surveyors have a bottom-up focus starting from the individual elements of the landscape. Geographers start from the big picture and work down; surveyors start from the details of lots of small pictures and work up.

geographers include macro traders such as George Soros, and global investors such as the late John Templeton. Examples of investment surveyors include Warren Buffett, and the retired Fidelity fund manager Peter Lynch. The economist J. M. Keynes was initially a geographer, following his “credit cycle theory of investment” in the 1920s, until he made a radical shift to a surveyor’s bottom-up philosophy after the 1929 crash.

Activists share many of the habits of thought of surveyors, and vice versa: whenever a surveyor takes action to address a management problem which arises at a company in which he is invested, rather than just selling the shares, he draws on the activist’s toolkit.

However, most surveyors try to avoid buying shares in companies which require management changes – that is, they do not go looking for trouble. The distinguishing characteristic of activists is that they are sometimes prepared to buy shares knowing that management changes are required. An activist is an investor who goes looking for trouble.

quiet freedom is itself exotic.

They live comfortably, eschewing the hedonic treadmill of competitive materialism on which those possessed of high salaries or bonuses often seem to run.

A reasonable observation put to me by one of the interviewees (Vernon) is that there are two types of luck. The first type, ‘lottery luck’, is wholly random – like winning a lottery – and exposure to its possibility requires negligible effort, like buying a ticket. But there is another type of luck characterised by a quotation attributed to the French microbiologist Louis Pasteur: “in the fields of observation, chance favours the prepared mind”.

only a few investors around the millennium (in this book, Sushil and Vernon) both made and kept fortunes from investing in technology shares. These investors were lucky, but their exposure to the possibility of this luck arose from their obsessive interest and diligence in investing over much of the 1990s. Although all of the people in this book have probably been helped by some good luck, it has arguably been mainly Pasteur luck, rather than lottery luck.

Aldous Huxley’s dictum: “the only completely consistent people are the dead”. [2]

The scarcest resource for successful investors is not money but attention: how to manage the trade-off between time and rationality to best effect. There is not time in life to find out everything about every potential investment. Investment skill consists not in knowing everything, but in judicious neglect: making wise choices about what to overlook.

Luke spends several hours every day observing and thinking about markets, and yet he deals only a very few times a year. He focuses on quality of decisions, not quantity of decisions, believing that “one of the big mistakes in investing is to think that you’ve always got to be doing something”.

In careers or in investment, it helps enormously to pick the right train – choose a field with long-term secular growth.”

In almost every era of stock market history, there are a few shares like this, and if you can find them, buy them and sit tight, your life can be transformed. You only need to find one or two really good investment ideas to change your life.

Once he holds a stock, his ongoing research is focused on confirming that it retains “low downside and substantial upside.”

he is indifferent to short-term price movements: “I try to watch the business, not the share price.” Nor does he lose sleep over the possibility that some other stock might offer even higher returns over the next few weeks or months.

He tries to get hold of analyst research on his main holdings “not for new ideas, but to see the extent to which the market is already discounting my own views.”

I hold the long-term view with greater confidence than the short-term one.”

“Most investors would have better performance if they thought more and did less. One of the great tricks in investment is learning to be happy doing nothing.”

Investment success is largely a matter of timing. One makes money by being one step ahead of the market; being three steps ahead can lead to trouble, even if you are ultimately right.

“A market doesn’t peak until the majority is convinced it is going to move higher, and it doesn’t bottom until the majority believes it must go lower.”

It opened my eyes to the fact that a frugal lifestyle can be creative and dignified. I realised that freedom is like income that cannot be taxed.”

Nigel will invest up to 5% of his total funds in a single company at the time of investment. He then follows a simple core rule: when a share doubles, sell half. He sees this as eliminating the original risk of the investment, by retrieving his capital for investment elsewhere, whilst retaining 50% of any further upside.

“It was an expensive lesson that all fundamental investors have to learn: the market can remain irrational longer than you can remain solvent.

aphorism of 19th century American philosopher William James [12] : “the art of being wise is knowing what to overlook.”

He thinks this defensive pessimism is a useful mental habit for an investor. “It is always easy to think of reasons to buy a company. That is what most tipsters do. To make good decisions, you need to look actively for reasons not to buy a company. And then invest only in those where you can live with those reasons.”

Warren Buffett’s maxim: “lethargy bordering on sloth remains the cornerstone of our investment style.”

As a further argument against market timing, he noted another conundrum. “If you think Armageddon is coming, what are you actually going to do? Sell all your shares and hide under the bed with a crate of whiskey? In that scenario, if Armageddon is averted, then with hindsight shares will have been a massive bargain. And if Armageddon materialises, you would have bigger worries than your share portfolio.”

“For me the stock market – particularly the small-cap sector – represents a hobby and a core activity, and I am never happier than when I am thinking, talking or writing about it.”

“The main benefit of money is freedom. There are two ways of gaining freedom: increase your assets or reduce your wants. I have always tried to use both approaches.”

“Naïvety at the right moment can be a strength, if it frees you to do the right thing. I was naïve enough to invest a large part of my portfolio in technology shares from about 1995 to 1998, and to stay in the sector as it rocketed through the summer and autumn of 1999. I did well by being one step ahead of the market – much better than if I had been three steps ahead. But as time went on, I was learning. So I was not naïve enough to go on buying technology shares in the Spring of 2000.”

larger investors like Sushil cannot do this; they need to buy and sell over a much wider range of prices. “When I buy a share, nine times out of ten I want the next move in price to be down, because I hope to buy more. And when I sell, I want the next move to be up, because I have more to sell.”

“One consequence of living a difficult life for many years when I was younger, making many surgical decisions with no good options and very high stakes, is what psychologists call flattened affect. Just being pain-free now is a source of happiness, so I don’t get very excited or upset about anything else. I think phlegmatism is a helpful trait for an investor.”

“To call it work is a travesty – I spend all day every day learning more about the world, doing things I enjoy.”

“Investment is a wonderful game, but it is largely derivative. You’re not building anything new. There is little original thought in investment.”

I wish I could live usefully rather than just die rich.”

Warren Buffett has summarised this point as follows: “Investment isn’t Olympic diving: there are no marks for degree of difficulty.”

“Reading a biography of Bernard Baruch made a strong impression on me. He was a plunger – that was how he made his fortune. [Gerald M.] Loeb’s The Battle for Investment Survival makes the same point: put all your eggs in one basket, and watch the basket. It made sense to me: to make a large fortune from a small one, you need to be a plunger.”

The concept of ‘scuttlebutt’ – small items of qualitative information gained from industry insiders, which can give an investor an informational edge – was first articulated in 1957 by the American investor Philip Fisher.

“When conditions change, you need to change your approach. It is much better to be right than to be consistent.”

Another metaphor he finds helpful is to “make sure you spend some of your time playing offence as well as playing defence” – where playing defence means monitoring the companies you already own, and playing offence means scanning the other 2,500 UK quoted companies for new ideas.

French microbiologist Louis Pasteur: “in the fields of observation, chance favours the prepared mind”.

It helps to be happy with being alone. “This concept of being happy alone is so culturally alien that English seems to have no positive words for it – only negative words like lonely, solitary, or isolated.”

He drew a distinction between activities with ‘positive scoring’, where success is defined by gaining wins, and activities with ’negative scoring’, where success is defined by avoiding faults.

Positively scored activities include selling, leadership, and most sports. In these activities bravery, ‘having a go’ and risk-taking give a better chance of success than careful deliberation, and the downside of making errors is low. Negatively scored activities include driving a car, piloting an aircraft, and anaesthetics in medicine. The successful driver, pilot or anaesthetist is not the brave one who always ‘has a go’, but rather the meticulous one who never makes any big mistakes.

“Learning modern portfolio theory to pick investments is like learning physics to play snooker.”

“Time is a limited resource with strongly diminishing returns. The first hour you spend researching a company is much more important than the tenth hour.

To limit the time resource applied to any one company, he reminds himself of psychological research which suggests that in many contexts decisions are best made with no more than five to seven points of information. Any more information beyond that does not significantly improve decisions, and may even degrade them.

He recognised an important paradox about small companies: they are less well researched, and yet easier to research. Compared to larger companies, the accounts are simpler, the directors are more accessible, and the business can usually be explained in a sentence or two.

“I have never felt that investing is like working. It is more like playing ten parallel games of poker or chess.”

In psychology there is a concept of time perspective, which describes how people parcel the flow of personal experience into a past, present and future, and the emphasis they place on each of these mental categories.

Some people have a primarily ‘present’ time perspective: they always live for the moment, with little thought or concern for the future. Others have a primarily ‘past’ time perspective: they dwell on memories, both good and bad, and see their current and future circumstances as determined largely by their past. A third group has a primarily ‘future’ time perspective: they focus on the future, and their actions in the present are shaped by long-term aspirations.

People with a stronger present time perspective may tend to spend rather than invest any increase in income which flows from career success, and so never get started as investors.

A common trait for all interviewees is the attitude that investment represents first and foremost a source of quiet freedom, rather than a source of ostentatious spending power.

“Leverage provides more juice, but in bad times that juice can quickly turn to hemlock.”

The philosopher Isaiah Berlin divided writers and thinkers into two categories, foxes and hedgehogs. These terms originate from a remark attributed to the Greek poet Archilochus: “the fox knows many things, but the hedgehog knows one big thing”. That is, foxes are eclectic, viewing the world through a variety of perspectives, with no allegiance to any single approach. Hedgehogs view the world through the lens of a single big idea – communism, capitalism, libertarianism or some other -ism.