Buffett suggests reading 3 key chapters to understand attitude required to succeed as an investor.
- Chapter 8 of Intelligent Investor (Graham)
- Chapter 20 of Intelligent Investor
- Chapter 12 of General Theory on Employment, Interest, Money (Keynes)
- timing - speculate on price movements
- pricing - buy assets less than their value, sell higher
Timing is not investing, argues Graham. It's too speculative and evidence of pundits across finance, econ, politics have failed to beat chance (Tetlock):
many pundits were hardpressed to do better than chance, were overconfident, and were reluctant to change their minds in response to new evidence.
Imagine you owned a small stake in a business, and you're called by a stranger everyday, Mr. Market, who unsolicited gives you a bid for your shares! Mr Market suffers from incurable emotional problems, swinging from euphoria to depression.
Because of this schism, Mr. Market is both rational and irrational, or at least you must believe this to conclude there is value in active investing. (After all, Fama (EMH) and Shiller (irrational exuberance) both won the Nobel in the SAME YEAR!).
A great litmus test for potential hedge fund / private client investors (or anyone who owns active mutual fund) would be to quiz them along these lines. Given that would instantly scare away all prospective client, I don't expect that to be part of sales process anytime soon.
“In the short run, the market is a voting machine but in the long run it is a weighing machine.” - Ben Graham
Market sometimes prices stocks incorrectly, but price and value ultimately converge in the future.
Another interesting, but less publicized phenomena of global financialization is that beating the index, (say S&P500) has never been more difficult.
Indeed, the standard deviation of excess returns for US Large cap funds 1967 to 2014 halved from 13% to 6%. Competition among funds, which grew from a total of 70 to over 1070 a culprit of eroding alpha (Markov Processes International, Morningstar, and Credit Suisse.)
Conversely, value investing works. Since 1920's its generated premium of 250 basis points over growth strategy, most of which occurred in time period described above.
Why? Is the result of risk or behavioral issues. The balance of the evidence suggests that the behavioral explanation better fits the facts.