12 October 1893, Atlanta (GA) Constitution:
Advice to those who want to get rich. Buy low and sell high.
GEO. S. MAY, Care May Maniel Company.
The golden rule of investing is to buy low and sell high. It’s a simple rule which guarantees positive returns. It’s so straight forward that anyone could follow it. The simple answer is that most investors find it hard to know in advance if a price is “low” or indeed to recognise that prices are “high” and ought to be avoided. With no understanding of whether current prices are high or low it then becomes almost impossible to navigate subsequent price volatility that occurs.
There are many examples of this practice in action. The rush for TMT stocks in 1999 is an extreme one – fund managers and individual investors fell in love with the productivity story and pushed prices to record levels. When these stocks corrected from 2000 to 2003 many were left nursing huge losses. More recently the rally in government bonds in the money-printing economies has pushed their yields to record low levels. Selling bonds now would be in line with the golden rule, while staying invested could lead to uncomfortable losses.
There are two main drivers that lead investors to struggle with the golden rule. The first is that they simply ignore it; after all, you can make just as much money buying high and selling higher. This is where we fall into the common behavioural traps: over confidence, herding, fear of regret etc. etc. It’s how bubbles can be formed, and how crashes can rapidly follow. It’s also a cause of the “yeah…buts,” as in: “yeah, I know these Treasuries are offering a negative real return… but the Fed is going to keep easing, everyone else will stay fearful, they’ve preserved capital for the last five years…”
Avoiding these traps is easy (you or I would never fall victim to this would we?), but the second problem is more challenging. How do we know what “high” and “low” are in the first place? All value investing is an attempt to establish this sense of a relative “highness” or “lowness” in assets and there are various ways of doing it. In our view being cute about different measures of value will only get you so far, but what you can observe are extreme departures and when these are accompanied by evidence of the overconfidence of others there will be plenty of situations for us to benefit from. We won’t get it right all the time, but if we buy low and sell high more often than not we will be doing OK.