FOMO – or Fear of Missing Out – has been blamed for many of the extraordinary moves we’ve seen in markets. As investors watch from the sidelines while others make fortunes, it becomes too tempting not to join in. Get The Full Warren Buffett Series in PDF Get the entire 10-part series on Warren Buffett in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues Q4 2020 hedge fund letters, conferences and more Ben Graham often wrote of irrational market moves like this, when ‘The investor’s greatest enemy turns out to be himself.’ He defined the difference between speculation and investment, but admitted that speculation is often more fun! At times like these, there are some really important things to remember for investors who intend to thrive and survive over the long term. Lessons from Ulysses Ben Graham read Classics and loved the Greek myths. His all-time hero was the wily adventurer, Ulysses. On his return voyage from Troy, Ulysses had to pass the Isle of the Sirens. The Sirens were beautiful mermaids, who would sing at passing sailors. Their singing was so seductive that sailors could not help turning their ships or swimming towards the island, where they would be dashed on the rocks and drowned. To avoid this fate, Ulysses’ crew put wax in their ears so they could not hear the Sirens. Ulysses had himself lashed tightly to the mast, so when he heard the singing, he could not free himself and swim to his death. In his book, Maps of Meaning , psychologist Dr Jordan Peterson explains that, even in their day, ancient myths were never viewed as accurate accounts of history or scientific explanation. Instead, they served as stories to teach people and communities how to act: and that is how ancient peoples used them, following the examples of their heroes. Graham viewed them in much the same way. He used the example of Ulysses as a lesson for investors. Ulysses is ultimately a tale of FOMO. In spite of his greatness, Ulysses knows he will not be able to resist the temptation, unless he prepares himself in advance with some sort of restraint. The Importance of Simple Rules Like Ulysses, investors need to plan in advance if they want to avoid being seduced and wrecked by FOMO. The answer lies in having some simple and time-tested rules to protect yourself. These should be: Rules that you actually believe in and are willing to stick to. Rules that are time-tested. Rules that are simple and objective, so you can measure yourself against them. Rules that are not pro-cyclical and cannot get hijacked by the market itself. A great example of daft rules is the current institutional fad for ‘risk metrics’, such as tracking error. Risk metrics like these are not only complicated, but force investors to actually buy more and more bubble stocks as they go up! Perhaps the best exemplar of simple rules was Walter Schloss. Walter Schloss was a student of Ben Graham and a friend of Warren Buffett. He never went to college and shunned computers and complicated models. He worked on his own out of a tiny office. Over 50 years his partnership out-performed the SP500 by over 8% per annum! His clients were a small bunch of wealthy families, many of whom stayed with him over his entire career, with their holdings passing down to children and grandchildren.
When asked to explain his approach, Schloss came up with this: A single A4 typewritten page of one-line rules he’d mostly picked up from Ben Graham’s night class. It wasn’t particularly original or surprising, and it certainly wasn’t complicated. What mattered was that Schloss had his simple rules, they were sensible, and he stuck to them. Walter Schloss and Why FOMO is an Illusion Shortly before Walter Schloss retired, he published a list of all the stocks he had owned over his 50-year career.[i] As you might expect for a consistent deep value investor, there were plenty of heavy industry stocks. But there were also plenty of tech and media stocks, consumer staples, telecoms, banks, insurers, restaurant franchises, healthcare... in fact practically everything was on Walter’s list! The point Schloss was making was that, over time, every stock and every industry had, at one time or another become a deep value stock that met his stringent criteria. He hadn’t needed to chase any of them, they all came to him. At some point, they all ended up in the bargain basement. FOMO is just an illusion. Now, fifty years might sound like a long time; but for the average saver starting out in their 20s or 30s, that is exactly the sort of timeframe they will be investing for. For charities and endowment funds, it is of course far longer. And, the good news is, with that sort of horizon, you get to buy everything dirt cheap, on your terms. A Postcard to Yourself A simple solution borrowed from psychology, is to write a postcard to your future self. It is simply a few lines on how you expect yourself to behave as an investor. Then put it in your desk drawer and look at it regularly, to remind yourself what you stand for, and see how you’re measuring up. Your Inner Scorecard The idea behind the postcard is to give you something consistent to measure yourself against. We know that markets can go wild in both directions. Further, the internet is full of people who claim to have made easy fortunes, most of which are, at best, exaggerated. So, instead of measuring yourself against the market or others, find some simple, timeless rules and principles you can always check yourself against. Warren Buffett calls this your Inner Scorecard. As Mohnish Pabrai recounts from his lunch with Buffett: He said, look - you can live your life in two ways. You can grade yourself based on what you think the world thinks of you - an outer scorecard, or you can grade yourself internally - an inner scorecard. He said, “Would you rather be the greatest lover in the world, and have the world think that you were the worst, or the worst lover in the world, and have the world think that you were the greatest?.” He said that if you know how to answer that question, then life becomes pretty easy.[ii] Warren Buffett and why FOMO is an illusion On several occasions, Warren Buffett has linked the market cap of the US stock market to US GDP as a handy rule of thumb for determining if the market is overvalued or not.[iii] Currently US equities are at a record high of 190% of GDP. The long-run average has been just shy of 100% of GDP, with a low of 32% in the early 80’s.
That suggests the US market is about 50% overvalued. Intuitively, the reasoning here is sound. Broadly, company profits grow with the economy. Another way to look at it is that when the stock market goes up, it creates paper wealth. However, if the economy is not growing at the same rate, there is not the real wealth (i.e. goods and services) to back up the paper wealth being created. So, one way or another, that paper wealth has to be destroyed. Most of those who have it will never get to spend it. It has to be this way. We have seen this time and again through history: the South Sea bubble, the Mississippi bubble, the Japanese bubble, the TMT bubble, the real estate bubble. In all these cases, the world was full of loud mouths showing off their newly made fortunes and boasting how easy it was. Very few kept them. It has to be this way. To put it another way, the stock market is normally a winners’ game, where the average investor is likely, over time, to come away with more than they put in. However, at points of speculative excess and overvaluation, it becomes a losers’ game, where the majority of investors will suffer major losses. Stepping aside from speculative phases or speculative securities means missing out on an emotional rollercoaster, financial pain, and the real bargains that are left behind long after the bubble pops. GameStop and Why Simple, Time-tested Rules Matter Most When You’re Winning Charlie Munger famously quipped, “It’s remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.” The risk is that we’re all prone to stupidity sometimes, and particularly when things are going well. It is at moments of triumph that we are most prone to throwing the rulebook out the window, and doing something dumb. A perfect example of this is the recent short squeeze in heavily shorted stocks such as GameStop. In a matter of weeks, this has cost many short sellers and hedge funds their careers, their reputations and their fortunes. It is a cardinal rule of short-selling that you never short a stock much above 15%. The reason is simple: When short interest gets much higher than this, it can get very hard to find enough stock to close out the short, triggering a short squeeze. If a short cannot buy enough stock, they can lose everything. This is a simple rule that has been around forever. It is there to prevent precisely this sort of thing. What is remarkable is that many of the stocks involved had short interests of over 60 or 70%! Not only that, some of them, such as Bed, Bath and Beyond, are buying back their shares at the same time. How could so many experienced and reputable short sellers be so dumb?! The answer lies in the fact that 2020 was such an amazing year for short sellers and hedge funds. Being long momentum (e.
g. tech) and short stocks that had already done badly (e.g. retail) was a popular strategy and it paid off big as Covid struck round the world. Drunk on their success, flush with cash and keen not to miss out on the next leg, the shorts completely forgot those simple, time-tested rules. It’s at those very moments they matter the most. The GameStop debacle also reminds us of something else about FOMO. Bubbles normally have a good reason for happening; such as a new technology, new markets or new methods of financing. There is a fundamental truth behind them; just as shorting traditional retailers in early 2020 made complete sense. That’s what makes them so alluring. What kills bubbles is not a flawed idea, but an idea that runs too far. It’s that combination of overvaluation, overinvestment, and mis-execution that sets up the disaster. And If You’re Not Missing Out... During the roaring 20’s, Ben Graham was a rising star of the investment scene. He had come from a poor family and was keen to enjoy his newfound wealth. He spent lavishly, with fine furniture, servants, and a long lease on a fancy New York apartment. His clients too had sky high expectations. When the Great Depression struck, Graham lost a lot of money, he struggled to meet his bills and he and his family faced financial uncertainty every day. His clients also suffered, making his work a constant battle and a burden. As his friends attested, Ben Graham’s experiences during the depression psychologically scarred him and led to more cautious approaches later on. Years later, Graham reflected that his luxurious new lifestyle did not make him any happier at the time, and brought only misery later on. With runaway stock markets just like the roaring 20’s, it is perhaps worth remembering a few things: Over the long-term, the best stock markets in the world have returned c. 5-7% real (i.e. after inflation). [iv] When average market valuations are high, as they are now, subsequent returns tend to be lower than the average. Less than 10% of investors beat the market over the long-term after costs. And of those that do, most do so by only 1 or 2%.
[v] Investors with the best returns over the past 3-5 years are statistically more likely to underperform over the subsequent 3-5 years and vice versa.[vi] Putting all this together, it probably means that if you’re making annualised returns much above 5% or 6% at the moment, it is probably not sustainable. As Ben Graham and many others have discovered, a newly lavish lifestyle won’t make you happy, but it could make you miserable and you could regret it. Keep it real. Firmly and honestly manage expectations for yourself and your clients. Don’t change your lifestyle much. Squirrel a bit away, reduce your liabilities, and maybe diversify a bit more, even if that means missing out a little. Surviving and Thriving in a FOMO World At company and stock market level, FOMO is an illusion. The vast majority of those involved will eventually see paper profits end up as real losses. It has to be this way. Like Ulysses, protect yourself from yourself. Don’t believe you are able resist market manias: ‘Speculation buys up the intelligence of those involved.’ So prepare in advance with a handful of simple, timeless rules and principles you believe in. Write those rules down, and measure yourself against them, not against markets. When things are going really well, double-check you’re sticking to those sensible rules – this is when they matter most. Be honest about what is sustainable, keep it real and don’t let your lifestyle get ahead of you. About the Author Andrew Hunt is a global deep value investor and author of “Better Value Investing: A Simple Guide to Improving your Results as a Value Investor.” End notes [i] schloss+-+list+of+stocks+-+january+2007.pdf (squarespace.com) [ii] Mohnish Pabrai's Advice For Value Investors (forbes.com) [iii] Market Cap to GDP: An Updated Look at the Buffett Valuation Indicator - dshort - Advisor Perspectives [iv] Credit Suisse Global Investment Returns Yearbook 2020 (credit-suisse.com) [v] Hiring Good Managers is Hard pdf (researchaffiliates.com) [vi] See e.g. http://www.economist.com/news/finance-and-economics/21569397-art-picking-mutual-funds-best-worst-and-ugly, and http://uk.businessinsider.com/performance-persistance-of-top-equity-mutual-funds-2015-6?r=USIR=T.