by Chris Lowe, International Man:
Chris Lowe (CL): From listening to you speak at events, and from conversations we’ve had, I’ve personally learned a lot from you about the principles of successful investing. If you had just one piece of advice for folks getting started as investors, what would it be?
Rick Rule (RR): A great place to start is the books of value investor Benjamin Graham.
When I was beginning my career, I had the opportunity to seek some advice from a legendary Canadian investor by the name of Peter Cundill. Peter was a follower of Graham’s value investing style. And he gave me a copy of Graham’s classic book, The Intelligent Investor.
I remember not wanting to read it at first. But eventually, I opened it. And after the first 10 pages, my life had completely changed. That book gave me the philosophical grounding I needed to become a successful investor.
That doesn’t mean I had the sense to follow Graham’s principles immediately. In my first decade as an investor, I violated every rule I had learned. Luckily, I eventually came to understand the rules I had violated… and why I paid the penalties for violating them. That’s something that doesn’t happen to many young men.
CL: One of Graham’s key themes is the difference between price and value. How do price and value interact with each other?
RR: Price is what you pay. Value is what you get. The problem most investors have is they rely on price information and conflate it with value.
Investors pay most attention to the price of an asset because it’s easy information to find. You can get it online… from the newspaper… or from your broker. Value is different. It’s hard to get. You have to work for it.
Being a successful investor involves exploiting the arbitrage between price and value. That is to say it involves buying things at a price substantially below either an investment’s value… or the value you think it’s likely to attain over time.
This kind of arbitrage between price and value is needed on the sell side, too. In addition to having the courage to buy low, a successful investor needs the wisdom to sell high. One of the things that happens when the price of an investment you’ve made goes up is the self-enforcing tendency to believe your thesis for more than it’s worth.
CL: You’re known as a contrarian investor. Why is that so important to you?
RR: I am a contrarian. But I struggle with the contrarian paradigm every day. Let me explain why…
As investors, we all believe we’re fact-seekers. We all believe we source information from various channels… and that we then assemble, dissect, and analyze that information rationally before drawing our conclusions. But that’s notwhat we do.
We certainly seek input from many places. But we seek input that makes us comfortable. We seek input that reinforces our existing views and prejudices. We assign most relevance to information that is familiar to us and that we are comfortable with. This is known in behavioral finance as confirmation bias.
We also all suffer from another cognitive bias known as recency bias. Our experience of the immediate past governs our expectation of the future. If an investment has been going up a lot lately, we tend to think it will keep going up. If an investment has been falling, we tend to think it will keep falling.
It’s our ability to think beyond these biases that makes us true contrarians.
CL: Is it also true that crowd-following investors tend to see changes in market cycles as “if” questions, while contrarian investors see them as “when” questions?
RR: I’m not sure that crowd followers, which I would categorize as momentum speculators, are the only culprits. Most investors look at the upside of a particular investment before they look at the downside.
Certainly, most momentum speculators invest in what’s popular. For example, you’ll notice that bitcoin moved from $400 to $2,000 before anybody cared. Then it gained tremendous attention.
The same goes for gold. In the early part of the last decade, the gold price moved up from $260 to $1,900 an ounce. But the rally didn’t come to popular attention until gold had moved past the $1,000-an-ounce mark. For most folks, there first had to be this move from $260 to $1,000 to substantiate the narrative of a bull market.
Only when gold moved from $1,000 to $1,900 an ounce did most people start asking the right questions: What if we begin to have sovereign debt defaults? What if there is a trade war between the U.S. and China? And so on.
Those questions were just as valid when gold was at $260 an ounce. It’s just that most investors needed the experience of rising prices to make them comfortable with putting their money on the line. And that leaves a lot of profits on the table.
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