I wrote this article almost two years ago, it is by far the most important article I ever wrote. I strongly encourage you to read it today. Successful investing is about following a successful, time-proven process in good and bad times (especially bad times). Of course, the problem with the process – though it may work in the long run, in the short-turn it may produce rather painful results. In today’s environment, sticking to the process by identifying great companies – the ones with strong balance sheets, wide moats, great management, conservatively valuing them (not forgetting to sub-normalize their earnings/cash flows) and buying them at a significant discount to their worth, has produced slightly better results than if you were to buy overpriced junk. But that is the short-run. Cyclical bear markets teach us to do the opposite of what we should be doing: they teach us to love cash – at the wrong time, they reward sell decisions as it raises cash and they keep punishing every buy decision we make.
I wanted to share with you an interesting anecdote. My partner, who is 30 years my senior, worked for a mutual fund company in the 1970s. His firm used a market timing service that got them out of the market in 1973 – they sold stocks and were in cash. The market declined over 40% in 1974. Victory! – right? Well, the market timing service did not get them back in on time and they missed the bulk of the 60% rise in the market in 1975.
Timing the market is very difficult because you have to get two things right at once: the economy and the emotions of the market’s participants. Good luck! For instance, even if you were brilliant and predicted that the subprime crisis will unfold in the summer of 2007 (though it could have happened in late 2006 or early 2008) the market did not care and went up 25% and made an all time high. Value individual stocks, don’t time the market – that is the only process that for most investors has proven to work in the long run. Thus we’ll be sticking to our process.