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Buffett's Strategy May Not Be Right for You... Here's One That Is

Oct 23, 2017

Rahul Shah, Editor, Smart Contrarian

For the longest time, I believed that stock markets didn't matter. I was confident it was all about individual stocks. As long as you are buying fundamentally sound companies at valuations that are not exorbitant, the stock markets can do what they want. Because if your stock selection is solid, I believed, sooner or later, the stock market will have to reward you for your smart picks.

And Warren Buffett did his bit to spread this philosophy.

  • I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.

But time and experience have taught me that while this philosophy fits Buffett's playbook perfectly, it isn't quite so simple for the average investor.

Unlike us, Buffett invests tens of billions of dollars in a single firm. So for him to move in and out of stocks every couple of years isn't practical.

His own buying and selling may cause the stock price to move a great deal. He therefore likes to buy stocks for keeps. His favorite holding period we all know is forever.

Individual Stock Picking: Myth or Reality?

It doesn't have to be like this for the rest of us though. We are much better off thinking in terms of 'the stock market' than 'a market for stocks'.

Because, come to think of it, there's really no such thing as a market for stocks.

Individual stock picking isn't the most successful of strategies out there. Someone of the calibre of Buffett can beat the stock market over the long run. But for the majority of investors, toiling hard to identify the next stock market winner doesn't add up to much. Even if you identify a winner or two, your overall portfolio returns won't look much better than the stock market.

You can see this clearly when you compare the returns given by the different market indices - like the small cap, mid cap and large cap - over a sufficiently long period of time. Now, there can't be group of stocks that are more diverse than the stocks comprising these indices.

Still, over the long term, the returns of these indices haven't been very different from each other. Over a 10-year period, the returns seemed to have moved in perfect step. This goes to show that over the long term, there's no guarantee any one group of stocks will outperform any other.

When Different Group of Stocks Perform the Same

And no matter how carefully chosen the stocks in your portfolio are, they can't protect you from a strong market correction. If markets correct like they did during the dot com bust or the 2008 crisis, no stocks are safe. It is a rare stock that does not suffer during such meltdowns.

The Big Picture Matters

Given this, it would be a mistake to assume that stock market movements do not have a bearing on overall investment results.

Individual stock selection is fine but to outwit the stock markets over the long term, you also need to take into account the movements of the broader market indices.

Which is why we love Benjamin Graham's suggestions that a great investment strategy should involve stocks trading well below their intrinsic values as well as smart allocation between stocks and bonds.

If you only focus on individual stock selection, you are likely to get results pretty similar to the overall stock market returns. To beat the stock markets, you, the investor, must act in a way that's different from the majority of stock buyers. You must be, a smart contrarian.

The Playbook for Market Beating Returns

In my services, I do this by reminding you to be fearful when the broader markets are greedy and greedy when the broader markets are fearful. In other words, I recommend subscribers allocate as much as 75% to stocks when the markets have had a correction and appear attractively valued, but that you change the allocation to 25% when they have gone up a lot and appear expensive.

This appears straightforward but isn't so.

When markets undergo a sharp correction, people, ruled by emotions, are naturally afraid of taking the logical step of maximum exposure to stocks. Likewise, when markets are buoyant, they want to increase exposure as they are overcome by the emotion of greed, when on the contrary, they should be doing the opposite.

It is exactly this simple strategy that has allowed my service, Microcap Millionaires, to outperform the benchmark indices by nearly 3x since inception.

When it comes to stock markets, there is one inescapable truth: No matter which stocks one chooses, prices will always fluctuate.

And unless you think independently from the crowd, you will likely get the same results as the crowds. Instead, use this strategy and chances are you will beat the markets comfortably over the long term.

Editor's Note: Just a quick reminder that today's the last day to take advantage of Rahul Shah's market beating service. Click here to get in before it closes at midnight tonight.

Good investing,

Rahul Shah
Editor, Smart Contrarian

Brain Food for the Day

How to Make Mr Market Your Servant

I think the best analogy of how to think about stock prices comes from none other than the father of value investing Benjamin Graham.

A lot of us, when we start out, automatically assume that stock prices are decided by the market. And therefore, they are accurate. But Graham wanted investors to get rid of this notion. He was of the view that this thinking is flawed and investors would be much better off in the long run by believing in his simple little story instead. And what exactly is this story. Well, it is about a gentleman who answers to the name of Mr Market. Here's Graham.

  • Imagine that in some private business you own a small share that cost you $1,000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly.

    If you are a prudent investor or a sensible businessman, will you let Mr. Market's daily communication determine your view of the value of a $1,000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.

Isn't this a 180-degree shift in mindset? Make Mr Market your servant and not your guide.

Mr Market comes to you every day with a quotation for stocks. It is entirely up to you to decide whether to buy from him or sell to him depending on the price he quotes.

On most days, you will do nothing. But when he is in very grumpy mood and offers you very low prices, you buy from him. And when he is extremely euphoric and quoting extremely high prices, you sell to him.

Trust me, you won't go wrong believing in this fable.

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