Finding bargains is not always enough. We want to find companies with characteristics of good businesses: good management, strong balance sheets, innovation, competitive advantages, returns to shareholders, earnings stability, and efficient operations.
When a company is deficient in quality we have to 1) analyze the probability of the deficiency being fixed and adjust the price we are willing to pay by increasing the required margin of safety.
Be certain the company has one or more sustainable competitive advantages, otherwise your bargain may be a value trap. Competitive advantages can be key company assets, attributes, or abilities that are difficult to duplicate. These could include being a low cost provider, pricing power, powerful brands, strategic asset, barriers to entry, adapting product line, product differentiation, strong balance sheet, or outstanding management/employees.
4. Avoid Portfolio Volatility
Portfolio volatility has a large negative effect on long term returns. If you have a positive return of 50% and a negative return of 50%, the arithmetic average is 0%. But you have actually lost 25%, or one-quarter, of your portfolio.
This means that it’s in your long term interest to lower the volatility of your investment portfolio. The mathematics of compounding make it compelling to avoid downside volatility.
You should expect volatility and take advantage of it. Make it a point to understand how volatility affects performance. Here are a couple of posts that will help you understand why you MUST control your portfolio losses and reduce your portfolio volatility.
5. Rethink Your Time Horizon
I contend that most investors fail, in the long run, because they try to beat the market in too short of a time horizon.1 Investing is a marathon, not a sprint. Put less focus on short term performance and greater emphasis on high probability strategies that create long term wealth.
Yes, I want to beat the market just like anyone else. But does it matter if I outperform the market this month, or this year, or even over several years? Or, are there more important considerations?
Understanding some simple truths about mathematics can help you be successful in the long run. Personally I have beat the market only 6 out of the last 17 years (2000 thru 2016). But is that important? During that period the AAAMP Global Value (part of my retirement portfolio) has significantly out performed the S&P500!
The problem with trying to beat the market in the short term is that it causes you to invest too aggressively when prices are expensive. The more expensive the market, the greater your emphasis should be on capital preservation.
What really matters is how your portfolio performs over a long period of time. Too short of a time horizon causes investors to focus on factors other than valuation and forget their investing principles .
How your portfolio performs over your entire investment time horizon is what’s important. Long term performance requires long term solutions and valuation should be the primary determinant of your investment decisions .
Both bull and bear markets move in long term cycles. An investor will find more opportunities (bargain prices) at the end of bear markets and at the beginning of bull markets. Therefore a value investors portfolio may be more volatile during times when bargains are available. This is because you should be more aggressive when prices are low.
However, there will be fewer opportunities (bargain prices) at the end of bull markets and the beginning of bear markets. An investor should have a portfolio that is less volatile when investment prices are expensive. This is because you should lower portfolio volatility and preserve your capital when investment prices are expensive.
Implement Your Beat the Market Plan
So after all this beat the market talk I’m going to ask you to stop thinking about beating the market. If you implement sound fundamental principles and strategies, with the long term in mind, the above average returns will follow.
The following article was republished with permission from Arbor Investment Planner.