Chapter 1: Planning to succeed
Your journey from novice to great investor
Colin Nicholson
As investors, we all start one day on a journey. At the beginning, we are complete novices. Many of us will be overwhelmed by the enormity of the learning process ahead of us. However, some of us will persist. If we stick at it, we will make the difficult transition into average investors. Then, with the application of more time and effort, a smaller number of us will progress to being good investors. From that point, the going becomes very difficult, as a small minority of good investors apply themselves to the necessary disciplines to one day become great investors. At this level making money is no longer an objective, it is simply a way of keeping score of our ability to beat the market. Figure 1.1 (overleaf) shows the journey.
From wherever we are on the journey as we read this chapter, there is a path to greatness if we are prepared to devote the time and to make the effort. It will be a long and demanding journey in terms of thinking through the issues and being prepared to change the way we think and do things.
Figure 1.1: the investor journey
Very few of us will follow the path right to the end. However, going as far as we wish to go is beneficial. Figure 1.2 is another way to see what is involved.
Figure 1.2: what’s involved in the journey
In my experience there are eight steps to becoming a great investor:
1 Learn how markets work and how to assess investment opportunities.
2 Create a written investment plan.
3 Gain experience by putting the plan into action and modifying it as necessary.
4 Track results against the objective of the investment plan.
5 Record investment reasoning in a journal at the time that each decision is made.
6 Evaluate decisions made in the investment process against the investment plan.
7 Identify aspects of the investment process that require improvement.
8 Devise and carry out a program of deliberate practice of these aspects.
Novices are only starting out: they achieve poor results
Novices are investors who are just beginning their investment journey. We all start out with the idea that investing must be easy. This is often because we hear friends talk about their successful investments. These are what we call war stories. They are always about successful investments and are designed to boost the reputation of the storyteller. This gives novices a completely unbalanced picture of investing because hardly anyone will willingly talk about the many other investments they have made that resulted in losses. Moreover, novices will never hear others tell what their overall portfolio return has been over the years, because most people do not calculate it.
As soon as we step onto the investing path as novices, we slowly begin to appreciate just how much we need to learn. Our first step might be to read one book. This will usually have been written to tell us what we want to hear, which is that investing is simple and easy if we just follow the methods of the author. Nothing could be further from the truth. However, as we start investing we soon begin to wake up to the real world of investing, which can be very complex and is far from easy. We may read more books and become more and more confused as different methods are proposed. Many of us will decide that we are not prepared to put in the time and effort to move along the path to the next stage. Those who give up completely at the novice level will turn to professionals to guide their investing decisions. This is a smart choice.
Average investors are well on their way: they achieve average results
Those of us who persist will realise at some point that we are setting out to learn a new profession. This will take us at least 10 years, as we gain the knowledge and develop the experience needed to make effective progress on our investment journey. This is the usual time to learn any similar profession. It took me much longer because I could not devote myself to it full time as a student would do. Ideally, we will undertake some formal education, avoiding expensive seminars and trading software. If we try to teach ourselves, it is likely to take even longer than a decade. Our goal is to reach the next stage on the investment journey, which is to become average investors.
As average investors, we will have begun to deepen our knowledge about how to assess investment opportunities. This should involve basic fundamental analysis and the elements of charting and technical analysis, both of which will have been integrated into our investment plan. Most of us will start investing before we have formulated an investment plan, which will evolve as we go along. The best of us will progress to the point where we have written down a complete investment plan. Our final step will be to start consciously putting our plan into action.
Good investors go a lot further: they achieve superior results
Good investors who have a strong desire to improve their investment performance will have formulated a written investment plan that is complete in every respect, suits their unique temperament and life experience and has been tested in the market over at least one complete bull–bear cycle. At this point, we will be ready to begin the more challenging part of the investment journey into becoming good investors.
To become good investors we need to integrate three further steps into our investing. At this stage of the journey, we will typically not know how our investing has panned out until we do our tax return at the end of the financial year. To move to the good investor level we need to be tracking our investment performance accurately against our investment plan throughout the year. This is the easy part of this section of the journey.
The tougher steps are to begin recording our analysis and thinking behind decisions at the time that we make them. This must be done at the time we make the decisions to avoid hindsight blurring our memory, which is what happens if our journal is written up after the event.
Our final test in this stage of the investment journey is even more of a challenge. We need to begin to evaluate our investment decisions from our investment journal against what we planned to do in our investment plan. This will prompt a lot of deep reflection and ongoing modification of our plan.
Great investors go all the way: they achieve outstanding results
Very few good investors among us will have the desire to attempt the climb to the summit. Typically, we will have come to the realisation that the problem is no longer that our investment plan was wrong. In fact it will already be very strong if we have climbed this far up the mountain. What we now need to face up to is that the last leg of our ascent to greatness in investing is all about working on the way we perform in trying to follow our plan. The final part of the previous stage in our journey will have exposed that we do not always follow our investment plan faultlessly. Now we must come to terms with how to change our own investment behaviour.
To do this and reach the summit involves the supreme effort for us as investors. From our evaluation of our investment performance against our plan we will start to identify those aspects where we need to improve. From this we will devise a series of programs aimed at working on these problem behaviours. Having done that, we engage in ongoing deliberate practice to develop and embed those skills. Like all elite performers in any field this will be an ongoing effort for the rest of our investing lives.
Not everyone will have the desire and dedication to try to reach the summit of investing skills. However, these ideas are still useful if we aim for lower levels and decide not to try to go beyond them.
At this point I will declare that I believe I have reached the level of a good investor. I am starting out towards the summit of great investing. I have studied what I think I need to do. During the remainder of this chapter I will discuss the key steps to becoming a good investor and outline what I think needs to be done to become a great investor.
Step 1: Learn how markets work and how to assess investment opportunities
I am going to assume that, as novices, we have begun to educate ourselves about the kinds of securities we might invest in, the way the relevant investment markets work and the basics of analysis. This is ideally done in a formal setting, starting with the free resources provided by the Australian Securities Exchange. This should move on into industry education, avoiding expensive seminars and trading software. Personally, I completed my formal education at post graduate level through what is now the Financial Services Institute of Australia (FINSIA), whose courses are now provided externally by Kaplan. After completing the qualification, I went on to devise two courses for FINSIA and to teach both fundamental and technical analysis. This was immensely valuable and underlines my experience that if we wish to deeply understand s...
