Chapter 29

Plan to succeed

In the preface to Benjamin Graham’s book The Intelligent Investor, Warren Buffett wrote that the two things an investor needs to succeed are:

• good decision-making skills

• discipline when under pressure.

Another way of saying this is that investment success requires learning to follow a sound investment plan.

An investment plan is a statement of objectives, strategy and tactics that describe how the investor is intending to operate. The plan should contain all the information needed to make investment decisions that manage the uncertainty that is inherent in the investment game. The plan will describe the kinds of stocks to be bought, when to buy them, how many stocks to buy, when to cut losses or take profits and lots more.

Every investor must develop a plan that will meet their objectives and is compatible with their investing horizon, knowledge, skills, experience, risk tolerance, attitudes, beliefs and personality. Unless it does that, the investor will not be comfortable with it and will not have the deep confidence in it that will enable them to hold to it when under pressure in the market. Faithful execution of the plan is more important than its detail.

There are many ways to make money in the markets, meaning there is no single plan that is right for everyone. Most people can find a method that gives positive results. This means they have a framework to make investment decisions. Then they strike the most common of all problems in investing: they find extreme difficulty in following their plan.

Gavin decides to invest in blue chip stocks, which have generous dividend yields and are selling at below-average price–earnings ratios. He decides that he will build a portfolio for his retirement. He intends to hold these stocks for many years. He thoroughly researches the top 100 stocks and chooses one that we will call Big Media Limited. Soon after buying it, the price of Big Media begins to rise steadily. Gavin soon has a 12 per cent capital gain on paper and a dividend is due in a few months’ time. Then the price of Big Media begins to fall. Soon it is back to where Gavin bought it. Worse still, it then slides to below his cost. Gavin comes under extreme pressure. When the price falls to 5 per cent below his purchase price, Gavin loses his nerve and sells to stop the pain he feels.

Gavin then selects another stock that we will call Mega Paper Limited. It does nothing for a while. Then a few months later it begins to rise nicely. Around this time Gavin notices that Big Media has also risen back above its previous peak and also paid a 20 per cent larger dividend. He decides that he will not make the same mistake again. Then Mega Paper announces a hostile takeover offer for a competitor. Despite Mega Paper’s protestation to the contrary, several influential pundits opine that the price it is paying is too high. Mega Paper’s price falls 25 per cent on the news and Gavin sells out in a state of shock.

Gavin then goes on to buy another stock. In time, Mega Paper recovers and a year later is selling for 35 per cent above Gavin’s buying price. A profit downgrade frightens Gavin out of his next purchase and so the pattern continues. What is wrong here is that despite having a perfectly sound investment plan, Gavin is unable to follow it. In short, he lacks discipline, which is the second of Warren Buffett’s requirements for success.

There is no magic solution to this situation, but we can devise a method to try to change this financially destructive behaviour. One way to look at it is that Gavin has to change his bad habit of reacting to short-term setbacks even though he is a long-term investor.

One popular and successful method for changing a habit is based on the idea that if we can consistently and consciously change a routine behaviour for about a month, there is a good chance that we can develop a new habit to replace the old one. This idea is aimed at habits that are manifested once or more each day. Investment habits like Gavin’s may only spring up and catch him out many months from the last occasion, so it will take more than 30 days to change. It may be more useful to think in terms of 30 investments. If a trader is buying and selling every day, she may only need 30 days to change a habit. However, an investor who buys more stocks each quarter out of his savings may need a year or so to develop a new habit.

This is a plan for developing discipline in investing:

Write out your investment plan. Make the plan as complete as possible. In deciding what should be in the plan, my book Building Wealth in the Stock Market will be a useful model. Consult a licensed financial planner if necessary.

Test your investment plan on many years of historical prices and over many stocks. You need to develop a high level of confidence that your plan can work in different market conditions.

Find a helper. This may be your spouse, a close relative or a trusted friend. Explain your investment plan to them. Agree with them that you will report regularly on your progress in following the plan. Make a firm appointment at the same time each month.

Begin an investment journal or diary. Write down your reasons for every decision you make. Remember that if something happens and you decide to do nothing, then that is still a decision. Write down how you assessed the situation, what the plan indicated in that situation and what you decided to do.

Reward yourself in some way each time you complete a week and have evidence in your diary that you followed the plan. The reward may be simple self-congratulation or it may be that you pamper yourself with some little luxury. Report progress to your helper. Ask them to check your diary and give you positive reinforcement when you are on track.

Write out an affirmation and stick it on the wall where you do your investment work. Word the new habit as though you have already achieved it; for example, I have stuck to my investment plan and it is paying off for me even in the face of short-term difficulties. Say it to yourself before and after each period in which you study the market and make decisions on your investments.

Of course, you will have problems doing this perfectly. You will slip back into your old habits from time to time. Your diary will record how you rationalised the decisions that were contrary to your plan, or did not take the opportunities that presented themselves. Don’t be too hard on yourself. You are only human and changing a habit is one of the most difficult of challenges for most people. It is important to not let your transgression reflect on your sense of self-worth as an investor. Instead, be conscious that it is normal that the path to changing a habit is rarely smooth.

When you slip up, review what you did wrong and write out in your diary what you should have done. Acknowledge the slip-up to yourself and to your helper. Forgive yourself for the indiscretion. Draw any lessons from it, which you write into your diary. Begin again.

Expect that some people will consciously or unconsciously sabotage your efforts. There are three things you can do about this. One is not to talk about your investments with other people unless you trust absolutely that they will only be positive and supportive of what you do. The second thing is to try to associate with positive people and avoid negative people. Finally, if someone who you cannot avoid is sabotaging you, it is important to use your assertiveness skills. Tell them what you would prefer they did in interactions with you about your investments.

Of course, there are always some investments that do not work out as your plan envisages. Having a diversified portfolio is the main way of dealing with this. No investment should be so large a proportion of your portfolio that a complete loss would be catastrophic. In any case, there should be a point where a loss becomes so large that the investment be sold. Both diversification and a maximum loss level are vital.

Summary

Exercising the discipline needed to follow a sound plan is the most important and difficult part of investing. If you are not succeeding, you may have developed financially destructive habits and behaviours. Identifying them is difficult, but not as difficult as changing them. This chapter sets out the steps to change a habit or behaviour.