Editor’s note: Today, we’re introducing you to our friend Whitney Tilson… Whitney has spent decades in the trenches of Wall Street, learning everything it takes to build tremendous wealth in the markets. And now, his newest venture – Empire Financial Research – aims to educate individual investors and help them make better decisions.
In today’s essay, we’re sharing some of Whitney’s most valuable insights. Today, you’ll learn more about his background, as well as four tips for beating the market over the long run…
In the past two decades, I have learned some valuable investing lessons…
My journey to launch Empire Financial Research has been unique. So please bear with me while I tell you a little about myself and my personal background…
My parents met in the Peace Corps in 1962. I was born four years later and spent much of my childhood in Tanzania and Nicaragua. In between, we lived in California, where my father earned his doctorate in education at Stanford University.
While we were there, I was one of 600 children who took part in the now-famous Stanford Marshmallow Experiment to study delayed gratification. (To this day, they still won’t tell any of us if we waited for the second marshmallow!)
Later, we moved to New England, where my father was the academic dean of an elite boarding school in western Massachusetts. I stayed in the area, attending Harvard University and later Harvard Business School, graduating with high honors at both. (Before graduate school, I helped my friend Wendy Kopp launch the Teach for America nonprofit educational program.)
Then, in late 1998, I raised US$1 million to launch my own hedge fund…
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They say it’s better to be lucky than good. I’d like to think I was a little of both. Over the next dozen years, I grew assets under management to US$200 million, nearly tripling my investors’ money in a flat market.
Toward the end, though, I made some key mistakes. I worried about another downturn, so I was too conservative with my portfolio… I took profits too quickly, held too much cash, and shorted too many stocks. After trailing this historic bull market for a number of years, I decided to close my funds and give my investors their money back.
I’m incredibly proud of my time in the hedge fund world. But when Porter Stansberry approached me with the idea of starting my own publishing company, I jumped at the chance.
I’ve long admired Porter for his business prowess. (After all, how many of us can say we launched what has become one of the world’s largest newsletter publishing businesses at 26 years old with a borrowed laptop at his kitchen table?!)
My new venture – Empire Financial Research – will allow me to share what I’ve learned over the past few decades on Wall Street with individual investors like you.
Anyway, that’s enough about me.
For the rest of today’s essay, I’m going to share what you’re actually here for: to learn the four steps that individual investors can take to beat the market over the long run…
The first step is the most important, and one: effective portfolio management.
This is such an important skill for investors to have, but I didn’t fully appreciate this early in my career. When I got into the business, I thought all I had to do was find cheap stocks and be a good stock picker.
It was only through hard experience that I came to learn that stock-picking is only half the battle. The other 50 percent is managing your portfolio, which can create or destroy as much value as the stocks you own.
To borrow a baseball analogy, your batting average matters a lot less than your slugging percentage. It’s not how many of your picks are right… it’s how much money you make when you’re right versus how much you lose when you’re wrong.
If you’re consistently sizing your best ideas too small, you’re hurting yourself just as much as if the stocks you buy go against you.
Another huge mistake many individual investors make is not being greedy enough. If you’re sitting on a big winner that runs up 50 percent or 100 percent, trimming your position can stunt your returns tremendously. The opposite is true, too. When you hang on to your losers way too long – or worse yet, average down on your position – your losses can mount quickly.
It’s critical to have the judgment, humility, and fortitude (which come from experience) to know when to let your winners run and cut your losses.
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Let’s say you’re a great stock picker and you assemble a portfolio of 10 companies… Over the next five years, seven of them are up big and the other three are down. Had you not touched your portfolio, your portfolio would have been in great shape.
But if you’re a poor portfolio manager, things can really start to go haywire.
In October 2012, I had nearly 5 percent of my portfolio in video-streaming company Netflix (Nasdaq; ticker: NFLX), right at its multiyear lows. And then it took off, becoming one of the greatest stocks of all time. But even though I had publicly predicted almost exactly what would happen, I only made about a tenth of what I should have. Because as the stock moved up, I kept selling and eventually exited far too early.
Had I simply gone away on a five-year vacation, I would have done far, far better – it’s up almost 50 times since then! It’s painful for me to see (and admit) that my management of the portfolio left a lot of money on the table. I ended up taking a portfolio that would have crushed the market and significantly trailed it instead.
In effect, my portfolio-management strategy was to pull my flowers and water my weeds… a deadly combination.
It’s also critical to give your investments long enough to let your thesis play out.
One of the biggest advantages individual investors have over professional money managers is the lack of short-term performance pressure.
Even the people who manage endowments and pension funds – which by definition have multidecade investing horizons – are evaluated on a short-term basis, sometimes even monthly.
But sometimes, stocks can remain cheap for years. It reminds me of an anecdote that investing legend Warren Buffett once said…
All I want to do is hand in a scorecard when I come off the golf course. I don’t want you following me around and watching me shank a three-iron on this hole and leave a putt short on the next one.
Meanwhile, 99 percent of the money in the world is managed by people who feel someone looking over their shoulders, ready to scold them for any mistake.
Sometimes stocks are cheap because they have no short-term catalyst to push shares higher. This means that they can languish for a while… But I’ve found that trying to anticipate when other investors’ sentiment will change is a mug’s game. It’s not the end of the world if a cheap stock remains depressed for a while… as long as you have an appropriate investing horizon.
I’d argue the only money you should be investing in the stock market is money you don’t need for three to five years. That sort of time frame gives you the patience to wait for high-quality stocks to go “on sale” and for your cheap stocks to start to move (assuming you’re right that they’re cheap!).
Next up is another core tenet of value investing: buying when the odds are in your favor.
In the value investing community, this goes hand in hand with what the father of value investing Benjamin Graham called “margin of safety.”
Imagine you’re driving a big truck over a bridge with a lot of other trucks on it that weigh a collective 49 tons. How would you feel if the bridge were engineered to hold only 50 tons?
When it comes to important things that your life – or financial future – depend on, you want to give yourself plenty of room to be wrong. Ideally, you want to consistently buy stocks where if you’re right, you double your money (or more) in two to five years, and if you’re wrong, you only lose a little.
That brings me to the last way you can put yourself in the position to beat the market: concentrating your portfolio in your best ideas.
Over the last half-century, a handful of folks figured out that Buffett is an investing genius, so they put their entire net worth into his holding company, Berkshire Hathaway (NYSE; ticker: BRK). That has obviously worked out well for them, but I highly recommend against such extreme concentration.
I think most investors should own somewhere between 10 and 20 stocks. This provides reasonable diversification, yet also allows you to concentrate on your best ideas.
These days, it’s becoming harder and harder to find stocks that the market has badly mispriced and undervalued… especially a decade into a complacent bull market like the one we’re in today.
The idea that any one investor can have real, proprietary insights – what I call “variant perceptions” – across dozens of stocks is hard to imagine. But by focusing on a handful of situations where you have an edge over the market, you’re likely to do far better than you would by owning dozens of stocks.
Editor’s note: Mark your calendars… On April 17, Whitney will go on camera to share his biggest investment prediction in 20 years. And he’ll even reveal the name and ticker symbol of what he calls the “No. 1 retirement stock in America” to everyone who tunes in.
Plus, just for signing up to attend this free event, you’ll receive access to a three-part video series on one of Whitney’s favorite companies… behind-the-scenes Q&A videos… and two more of his strongest-conviction ideas. Reserve your seat right here.