Why Most Investors Earn Subpar Returns

One of the fascinating things about investing is that there are so many different strategies that work. I have been reading two books recently on investing that cover two completely opposite styles, but interestingly, both of them work.

The two strategies I’m talking about are net-net investing and quality investing, as profiled in the books “Benjamin Graham’s Net-Net Stock Strategy” by Evan Bleker and “The Art of Quality Investing” by Compounding Quality and Luc Kroeze.

The goal of net-net investing is to find stocks selling below liquidation value in “the stock market’s trash,” while the goal of quality investing is to “buy only the best” at reasonable prices.

Net-net investing works because the market is taking such an extremely pessimistic view of these companies that if you buy a basket of them, there is typically low downside and considerable optionality to the upside.

Quality investing works because great companies can usually continue to be great for a long time, have high margins, and can reinvest cash flows profitably. So, it makes sense to pay reasonably high prices and hold for a long time while they compound underlying value.

These strategies are complete opposites of each other, but they both can work well. They have different things that make them work, such as different holding periods, portfolio strategies, risk management, and so on. But ultimately, both can make for great returns.

Reading about these two different strategies got me thinking about why it’s so difficult for most people to invest successfully even though there are so many well-documented strategies that can work for them.

The more I learn as an investor, the more I realize that the most important determinant of success is typically not what stocks you buy or sell, but instead if you are following a strategy that works and is suited to your temperament.

I have found that when things go well, we all like to tell ourselves that we have conviction in what we are doing. But if we get a few years of subpar returns or even lose money, while someone else is making money doing something else, it’s hard to be disciplined.

And that’s where I think the most dangerous mistakes in investing come from. When you are frustrated with something that has not been working for some time and go chase something that has been working for a long time, you are likely to be selling low and buying high instead of doing the opposite.

Take, for example, the well-documented and historically valid strategy of dollar-cost averaging into the S&P 500 each month and holding for a long time. For that strategy to work, you have to invest not only when the S&P is doing well, like it is right now, but also when it’s not doing well.

But how many people do that? 

Do you think many investors following that strategy bought the S&P 500 all the way to the bottom in the financial crisis in 2009 when the S&P had crashed 50% in a year and then continued doing so back up from the bottom? 

I would guess not.

And in the next market crash or a period of underperformance for the S&P, what will they do then?

It’s difficult to follow a strategy through thick and thin and have conviction, so most people don’t. Instead, they start winging it, usually at the most inopportune time, and that’s the reason why they earn subpar returns.

I believe the most important thing for an investor to be successful is to find a strategy that makes sense, has a history of working, and has reasons to continue working. And even more importantly, find a strategy that works for you and your temperament and will allow you to have conviction through thick and thin.

Thanks for reading and have a great weekend!

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Disclaimer: This article is for informational purposes only and does not constitute investing advice. Please consult with a qualified financial advisor before making any investment decisions.