In total, there are 7 key traits that I believe are
necessary to become a successful long-term Active
7 Traits for Investing Greatness:
Author: Jim O'Shaughnessy, Investing September 15,
2017
Years of experience have taught me that becoming a
successful Active investor is extremely difficult,
requires a very specific set of characteristics, and that
many investors attempting to actively manage their
portfolios today lack the emotional and personality
traits necessary for success.
Investors with Passive portfolios presuming they are
adequately and broadly diversified face only one real
point of failure: reacting emotionally to a market
selloff and selling their holdings, often near a market
bottom.
But investors who use actively-managed strategies are
confronted with 2 points of failure:
1. Reacting emotionally to a market selloff and
liquidating their holdings.1
2. Selling out of an Active strategy because it is
doing worse than its benchmark.2
The second point of failure occurs even if the
investor has earned positive returns in the
Active strategy lets say a gain of 10% per year over
the last 3 years versus a benchmark return of 12%.
While all investors face the same point of failure when
selling during market swoons, only Active investors
face the second pitfall. Whats more, research has
shown that managers who are fired due to a 3-year
underperformance typically go on to outperform the
manager with which the investor replaces them.3
Of course, this second point of failure can destroy
long-term results even if the general market has been
performing well. Sadly, I see this type of behavior
often, leading me to conclude that, for many investors,
Active management will never work precisely because
they lack the emotional and philological traits required
to succeed.
investor. Lets look at the first one here, and the other
6 in future posts:
1. Long- or Short-Term?
Successful Active Investors have a Long-Term
Perspective on their Investments.
Having, and sticking to, a true long-term perspective
is the closest you can come to possessing an investing
super power.
@CliffordAsness (1/25/17 9:32 p.m.)4
Mr. Asness is 100% correct but, sadly, most investors
lack this ability. Evolution has programmed us to pay
far more attention to what is happening now than to
what might happen 10 or 20 years into the future. For
our ancient ancestors, that made a great deal of sense.
Those who reacted quickly to a rustling sound in a
nearby bush presuming it was a predator who could
kill them ran away and survived, whereas those who
didnt were often killed. Guess whose genes got passed
down to us? Of course, it was those that ran away from
the rustling bush, even if there was no fatal threat.
Our culture has evolved much more rapidly than our
brains, which doesnt help us keep a long-term
perspective on our investments. When you time-
weight short-term information for investment
decisions, you create a reactionary model, not an
anticipatory one.
Many behaviors that hobble making good investment
choices seem to be encoded into our genes. In their
2012 paper Why do Individuals Exhibit Investment
Biases?, Researchers Henrik Cronqvist and Stephan
Siegel explain it this way:
We find that a long list of investment biases (e.g., the
reluctance to realize losses,5performance chasing,6 and
the home bias7) are human, in the sense that we are
born with them. Genetic factors explain up to 45% of
these variation in those biases across individuals. We
find no evidence that education is a significant
moderator of genetic investment behavior.
Wow! Its no wonder that the majority of investors
succumb to short-term volatility in the market by
selling and waiting until markets have been very
strong to begin buying, even though more than 30
years of studies have proven this is exactly the wrong
thing to do. Its literally programmed into our genes
and is impervious to education. We are also prone to a
slew of cogitative biases, from overconfidence in our
own abilities8 to our tendency to overweight things
simply based upon how easily they are recalled.9 And
knowing about our biases of judgment something
that has been noted in market research for more than
30 years hardly eliminates them.
Successful Active investing runs contrary to human
nature. Its encoded in our genes to overweight short-
term events, to let emotions dictate decisions and to
approach investing with no underlying cohesiveness or
consistency. Successful Active investors do not comply
with nature; they defy it. The past, present, and future
make up the now for them. Its not natural to remain
unmoved when watching others get caught up in
spirals of greed and fear, causing booms and panics.
Its not natural to remain unemotional when short-
term chaos threatens your nest egg. And, leading to my
next required trait (Valuing Process over Outcome),
its not natural to persevere in a rigorous, consistent
manner no matter what the market is doing.
1. Usually this happens at the least optimal time! When it
happens at or near the market bottom, the investor basically
locks in their losses.
2. Can investors measure performance over periods as short as 3
years? In hindsight, look at how misleading even a 5-year
period can be. Between 1/1/1964 and 12/31/1968, $10K
invested in Portfolio A (annually buying the 50 stocks in the
Compustat database with the best annual growth in sales)
soared to $33.5K in value, a compound return of 27.3% per
year more than double the S&P 500 (10.2% annual return,
$10K only grew to $16K). Unfortunately, the Portfolio A
strategy didnt fare so well over the next 5 years. Between
1/1/1969 and 12/31/1973, it lost more than half its value (losing
15.7% per year) versus a gain of 2% for the S&P 500. Think of
the hapless investor who watched these types of stocks soar in
value for the 5 years ending 12/31/1968. By doing what they
considered homework that is, reading all the glowing
reports in the press about the impressive returns generated by
the gunslingers on Wall Street and not taking the plunge
until 1969, their $10K wouldve dwindled down to just $4K.
Yep, so much for only paying attention to a 5-year record.
3. See Josh Browns TheReformedBroker.com/2014/08/07/fired-
managers-outperform-hired-managers
4. Tweet from Cliff Asness, Co-Founder AQR Capital
Management. In reply to query the next day (Any advice on
how to do this successfully?), Mr. Asness offers this sage
advice: Get yourself bitten by a radioactive Buffett or Bogle.
5. See wikipedia.org/wiki/Loss_Aversion
6. See
pressroom.vanguard.com/nonindexed/Quantifying_the_Impa
ct_of_Chasing_Fund_Performance_July_2014.pdf
7. See Portfolio Patriotism, and Why You Should Avoid It
5/3/14 (investorfieldguide.com)
8. See wikipedia.org/wiki/Overconfidence_Effect
9. See wikipedia.org/wiki/Availability_Heuristic
2. Process, or Outcome?
Successful Active Investors Value Process over
Outcome.
If you cant describe what you are doing as a
process, you dont know what youre doing.
W. Edwards Deming
The vast majority of investors make investment
choices based upon the past performance of a manager
or investment strategy. So much so that SEC Rule 156
requires all money managers to include the disclosure
that Past Performance is not Indicative of Future
Results. Its ubiquitous and routinely ignored by
both managers and their clients. In keeping with
human nature, we just cant help ourselves when
confronted with great or lousy recent performance.
Whats the track record? is probably the question
asked most frequently by investors when considering a
fund or investment strategy. And, as cautioned in Part
1 of this article, that vast majority of investors are most
concerned with how an investment did over the prior
1-year or 3-year period.
Yet successful Active investors go further and ask,
Whats their process in making investment
decisions? Outcomes are important, but its much
more important to study and understand the
underlying process that led to the outcome, be it good
or bad. If you only focus on outcomes, you have no
idea: Is the process that generated the desirable
outcome superior or inferior? This leads to
performance chasing and relying far too much on
recent outcomes to be of any practical use. Indeed,
shorter-term performance can be
positively misleading.
Look at a simple and intuitive strategy of buying the 50
stocks with the highest annual sales gains.1 Consider
this not in the abstract, but in the context of what
actually happened in the previous 5 years:
The $10K invested in the strategy grew to $33.5K,
doubling the same investment in the S&P 500, which
grew to $16.2K. The 3-year return (the metric that
almost all investors look at when deciding if they want
to invest or not) was even more compelling, with the
strategy delivering an average annual return of 32.9%,
compared to just 7.4% for the S&P 500.
Also consider that these returns would not appear in a
vacuum. If this were a mutual fund, it would probably
have a 5-star Morningstar rating, it would likely be
featured in business news stories quite favorably, and
the long-term proof of the prior 5 years would
suggest that this intuitive strategy made a great deal of
sense and therefore attract a lot of investors.
Heres the catch the returns are for the period from
1964 through 1968. This was a time when, much like
the late 1990s, speculative stocks soared. Investors
without access to the historical results for this
investment strategy would not have the perspective
that the long-term outlook reveals, and thus might
have been tempted to invest in this strategy just before
its impending crash and burn.2
3. Consistent, solid earnings over a long time
period
4. Low and manageable debt
5. Good ROE and other solid ratios
These criteria seem like sensible ways to buy stocks,
and Buffett showed no signs of deviating from the
strategy he was (and is) patient and persistent,
sticking with a proven strategy even when it isnt
working in the short term. Now take a look at Buffetts
Base Rates (using Berkshire Class A stock) from 1977
through 2016:
Base Rates: Berkshire Class A (BRK.A)

Had an investor had access to long-term returns, they

would have seen that buying stocks only based on their
annual growth of sales was a horrible way to invest
the strategy only returned 3.9% per year between 1964
and 2009! Investing $10K in the 50 stocks from All
Stocks with the highest annual sales growth grew to
just $57.6K at the end of 2009, whereas the same BRK.As Base Rates are very similar to investing in the
$10K invested in U.S. T-Bills compounded at 5.6% per cheapest 10% of stocks using What Works on Wall
year, turning $10K into $121K. In contrast, if the Streets Value Composite 1, which ranks stocks on
investor had simply put the money in an index such as the basis of:
the S&P 500, the $10K would have earned 9.5% per
year, growing to $639K over time. What the investor 1. Price-to-Book6
would have missed during the phase of this strategys 2. Price-to-Earnings
exciting performance is that valuation matters a 3. Price-to-Sales
lot. Turns out this type of stock is usually very 4. EBITDA-to-Enterprise Value
expensive, and very expensive stocks rarely make good 5. Price-to-Cash Flow
on the promise of their sky-high valuations.

Thus, when evaluating an underlying process, its (19642009)

important to decide if it makes good sense. The easiest
way to do that is to look at how the process has fared
over long periods of time. This allows you to better
estimate whether the short-term results are due to luck
or skill. To do this, we like to look at a strategys rolling
Base Rates.3

Lest you think this could only be accomplished with

quantitative strategies that can be backtested, consider
Warren Buffetts results at Berkshire Hathaway. If you
were making a choice about whether to invest in
Berkshire stock using short-term results at the end of
1999 as a guide, you probably would have passed them
by.4
This process always focuses on the cheapest stocks in
the universe and makes a great deal of intuitive sense,
backed up by its process and the performance over
time.

But if you checked on Buffetts process, you would find

that nothing had changed and that he still adhered to
the same stringent criteria he always had, generally
seeking for stocks with:

1. Recognizable brands with a wide moat5

2. Simple, easy to understand products and

services
3. No Fortune-Tellers
Successful Active Investors Generally Ignore
Forecasts and Predictions.
I dont let people do projections for me because I
dont like throwing up on the desk.
Charlie Munger
I have no use whatsoever for projections or
forecasts. They create an illusion of apparent
precision. The more meticulous they are, the more
concerned you should be.
Warren Buffett
You cant turn on business TV or read all the various
business news outlets, or even talk with other
investors, without being bombarded by short-term and
long-term forecasts and predictions. Against all the
evidence, forecasts and predictions about what might
happen in the future are intuitively attractive to us,
since we are desperate to have a narrative about how
the future might unfold. As I mentioned above, we
tend to extrapolate well into the future with what has
happened recently, which almost never works. Well
explore the results of this in a minute, but for now,
consider that since we literally hear or read so many
forecasts about markets, stocks, commodity prices, et
cetera that to follow up on the efficacy of each would
be a full-time job. Lucky for us, others have done this
job for us, and the results are grim.7
In his book Contrarian Investment Strategies: The
Psychological Edge, money manager and author David
Dreman looked at the accuracy of analysts and
economists earnings growth estimates for the S&P
500 between 1988 and 2006. Dreman found that the
average annual percentage error was 81% for analysts
and 53% for economists! In other words, you might as
well have bet on a monkey flipping coins (as
mentioned in my Feb. 2017 MoneyLife
Radio interview).
People tend to take recent events and forecast similar
returns into the future. Dreman nicely captures the
results by looking at large international conferences of
institutional investors where hundreds of delegates
were polled about what stocks they thought would do
well in the next year. Starting in 1968 and continuing
through 1999, Dreman found that the stocks
mentioned as favorites and expected to perform well
tended to significantly underperform the market. In
many instances, the selected stocks ended up in the
stock markets rogues gallery. As an example, the top
pick in 1999 was Enron, and we all know what
happened there: one of the largest bankruptcies in
corporate history.8
To avoid seeming like a cherry-picker, Dreman looked
at 52 surveys of how the favorite stocks of large
numbers of professional investors fared between 1929
and 1980, with 18 studies including 5 or more stocks
that experts picked as their favorites. The results? The
18 portfolios underperformed the market on 16
occasions. As Dreman dryly notes: This meant, in
effect, that when a client received professional advice
about those stocks, they would underperform the
market almost 9 times out of 10.
If you need more recent evidence, Nazim Khans 2012
Financial Forecasts Gone Wrong reveals even more
famously wrong forecasts.9 As well, the results of an
August 2000 Fortune Magazine article 10 Stocks to
Last The Decade: A few trends that will likely shape
the next 10 years. Heres a buy-and-forget portfolio to
capitalize on them provides even more proof.10 The
results? As of 12/31/2016, those 10 stocks11 were down
27%, versus the S&P 500s 116% gain.
Finally, many studies have shown that this pattern is
common to almost all forecasts in virtually every
other industry where professionals make predictions
and forecasts, whether forecasting stock prices, or the
number of patients needing medical treatment, or the
accuracy of college admissions offices trying to pick
who to admit in virtually every other industry where
professionals make predictions and forecasts.12
1. Also see Short-Term Luck Versus Long-Term Skill
(jimoshaughnessy.tumblr.com/post/137235375474/short-
term-luck-versus-long-term-skill).
2. As the data from What Works on Wall Street makes plain, over
the very long term, this is a horrible strategy that returns less
than U.S. T-bills over the long term! See The Less You Pay, the
More You Earn
(jimoshaughnessy.tumblr.com/post/92760346789/the-less-
you-pay-the-more-you-earn).
3. Base Rates create a movie as opposed to a snapshot of how
strategies perform in a variety of market environments. For
more, see Base Rates are Boring (And REALLY Effective)
(http://jimoshaughnessy.tumblr.com/post/94558957584/base
-rates-are-boring-and-really-effective)
4. Indeed, your decision would have been reinforced by the news
stories circulating that Buffetts simple process no longer
worked in the tech-dominated new normal for the stock
market. Thats because, over the previous 3 years, Berkshire
underperformed the S&P 500 by 7.6% per year, and 3.8% per
year over the previous 5 years.
5. Wide moat: A competitive advantage that a business possesses
that makes it difficult for rivals to wear down its market share
and profit. (investopedia.com/terms/w/wide-economic-
moat.asp)
6. Full disclosure: OSAM does not use P/B (price-to-book)
in any of our strategies. For more background, see Price-
to-Books Growing Blind Spot (osamlibrary.com).
7. In a post at his website TheInvestorsFieldGuide.com, my son
and fellow OSAM Portfolio Manager, Patrick OShaughnessy,
highlighted a study that showed that The CXO Advisory group
gathered 6,582 (investment) predictions from 68 different
investing gurus made between 1998 and 2012, and tracked the
results of those predictions. There were some very well-known
 names in the sample, but the average guru accuracy was just
47% worse than a coin toss! Of the 68 gurus, 42 had accuracy
scores below 50%.
8. Brilliantly profiled in Bethany McLean & Peter Elkinds
2013 The Smartest Guys in the Room: The Amazing Rise and
Scandalous Fall of Enron.
9. See morningstar.in/posts/12556/financial-forecasts-gone-
wrong.aspx
10. See
archive.fortune.com/magazines/fortune/fortune_archive/200
0/08/14/285599/index.htm
11. Now only 8 stocks Nortel and Enron went bankrupt.
12. For more on this, check out The Unreliable Experts: Getting in
the Way of Outstanding Performance
(jimoshaughnessy.tumblr.com/post/127484251129/the-
unreliable-experts-getting-in-the-way-of).
4. Restless & Relenting?
Successful Active Investors are Patient &
Persistent.
Nothing in this world can take the place of
persistence. Talent will not: nothing is more common
than unsuccessful men with great talent. Genius will
not: unrewarded genius is almost a proverb.
Education will not: the world is full of educated
derelicts. Persistence and determination alone are
omnipotent.
Calvin Coolidge
In addition to having a well thought out process
(see Part 2 of this article), great Active investors are
patient and persistent. Warren Buffett, Ben Graham,
Peter Lynch, John Neff, and Joel Greenblatt are all
great investors whove passed the test of time despite
intense scrutiny and criticism. While each of them
have very different ways of looking at the stock market,
they all share a common disposition: they are patient
and persistent.
As an example, in 1999, numerous articles and TV
features suggested that while he might have been
great in the old economy Buffett was well past his
prime and was out of step with the new market
reality. Buffetts response? He noted that nothing had
changed on his end of things and that he would stand
pat with the process that had served him so well for so
long.
The same could be said for every investor on the list.
John Neff, a great value investor who helmed
Vanguards Windsor fund and beat the S&P 500 by
3.1% per year over his 31-year tenure. In the early
Nineties, I remember the cover of Institutional
Investor magazine showing a man inside an hourglass
where the sand had nearly emptied from the top, along
with the question: Is value investing dead? Neff, who
favored stocks with low P/E ratios, high dividend
yields, and good return on equity (and who had
therefore had been underperforming over the short
term!), did the same as Buffett. Neff patiently stuck
with his process focusing on cheap stocks with strong
yields and high ROE. He went on to deliver great
returns for his investors.
The point is clear: successful Active investors are not
simply defined by their process (since many have very
different approaches and processes that they follow).
Rather, its their diligence and persistence in sticking
with their strategies even when they are
underperforming their benchmarks. As well, all these
investors are also defined by the clarity of their
process.
John P. Reese and Jack M. Forehand wrote a book
called The Guru Investor: How To Beat The Market
Using Historys Best Investment Strategies,1 in which
they methodically create checklists that investors can
follow to emulate their favorite Manager. Now, while
their interpretation of a managers criteria is open to
debate, they do a good job of creating checklists for the
investors they attempt to duplicate, usually using
either books or statements from the manager to
generate their criteria. They also maintain a website
(validea.com), which details the performance and
current stock picks from each of the managers they
follow. For example, much like the list of criteria
already covered for Buffett, heres the process they use
for emulating Ben Graham:2
1. No technology companies, company must have
high sales
2. Current ratio of at least 2.0
3. Long-term debt does not exceed net current
assets
4. Steady EPS growth over the past decade
5. 3-year average P/E is less than 15
6. Price-to-book times P/E is less than 22
7. Continuous dividend payments
According to their website, applying these criteria to
select stocks has returned a cumulative gain of 377%,
outperforming the market by 248% since 2003! Also at
their website, you can see how other managers
performed. Note, validea.com subtly anchors you in
the long term by presenting the cumulative return over
the prior 13 years, thus reinforcing the idea that you
should only judge Active performance over very long
periods of time.
If youd only been looking at the recent performance
for the Channeling Ben Graham strategy, it would
have led you to a very different conclusion3 Given the
strategys dismal 2014 and 2015, do you really think
you wouldve had the patience, persistence, and
emotional fortitude to stick with it? For the vast
majority, the answer is a resounding no. For successful
Active investors, the answer is an emphatic yes.
Patience and persistence would have paid off in 2016,
with a gain of 20% versus a gain of 9.5% for the S&P
500. More importantly, keeping the long-term track
record in mind would have immensely helped an
Active manager or investor to stay the course.
5. The Importance of PMA4
Successful Active Investors Have a Strong
Mental Attitude.
Nothing can stop the man with the right mental
attitude from achieving his goal; nothing on earth
can help the man with the wrong mental attitude.
Thomas Jefferson
Ben Graham believed that great investors are made,
not born. It takes constant study, learning from both
your own experience and that of others to create habits
that lead to success. I believe that one of the habits
that is not innate but learned is a strong mental
attitude. I think that most successful Active managers
not only have strong mental attitudes, but many
border on stoicism.5 Stoics taught that emotions
resulted in errors of judgment and they thought that
the best indication of someones philosophy was not
what a person said, but how they behaved. In the
words of Epictetus,6 Its not what happens to you, but
how you react that matters.
Successful Active investors understand, as Napoleon
Hill stated, The only thing you control is your mind.
Practically, this means that you do not base your
actions, feelings, emotions, and thoughts on external
events good or bad or on what other people are
doing or saying, none of which are in your control, but
rather on your own actions, beliefs, and habits, all of
which are in your control.
Successful Active investors do not blame others or
events; they do not shirk from their personal
responsibility for how things turn out, but rather
continually focus on their process and trying to
improve it. They learn from every lesson, be it good or
bad, and continually strive to incorporate that learning
into their process. Above all, they understand that you
must control your emotions rather than let them
control you.
They understand, as Shakespeare famously wrote,
there is nothing either good or bad, but thinking
makes it so.7 Events very much depend upon how you
interpret them. What might cause one person to react
emotionally to something is treated as a learning
experience by someone with a strong mental attitude. I
think that this is a disposition that is learned and
rarely innate. It is very helpful on the journey to
becoming a successful Active manager to keep a
journal of how you reacted to various events and
outcomes. This lets you see if there is a common
thread that keeps you from succeeding. If so, then you
can actively work to replace those behaviors.
By doing so, you reinforce the belief that the only one
controlling your mind is you, which strengthens the
synaptic connections8 in your brain that allow you to
make this type of thinking more natural.9 Once
accomplished, your thought patterns and mental
attitudes become vastly more useful than reacting from
base emotions such as fear, greed, envy, and hope.
After habituating yourself, this mindset frees you to
persistently follow your process, even when it is not
working in the short term. Years before the DJIA was
created, Ralph Waldo Emerson proclaimed, To map
out a course of action and follow it to the end
requires courage. And, I would add, a strong
mental attitude.
1. (Feb. 2009) wiley.com/WileyCDA/WileyTitle/productCd-
0470377097.html
2. See Graham/Dodds seminal Security Analysis: Sixth
Edition (includes a Foreword by Buffett).
3. In 2014, the strategy lost 22.9% versus a gain of 11.4% for the
S&P 500 and in 2015 it also lost 20.4% versus a slight loss of
0.7% for the S&P 500. If you started using the strategy at the
start of 2014, your account would show a cumulative loss of
39% at the end of 2015 versus a 10.62% gain for the S&P 500.
4. In 1937, Napoleon Hill first developed and introduced the
Positive Mental Attitude concept in the book Think and Grow
Rich. Though Hill doesnt actually use the phrase verbatim in
that book, he develops the importance of positive thinking as a
principle to success. (Later, PMA is used verbatim in his book
title Success Through a Positive Mental Attitude.)
5. See Ryan Holidays 2016 The Daily Stoic: 366 Meditations on
Wisdom, Perseverance, and the Art of Living.
6. From Wikipedia: Epictetus (born c. 55 A.D.) taught that
philosophy is a way of life and not just a theoretical discipline.
To Epictetus, all external events are beyond our control; we
should accept calmly and dispassionately whatever happens.
However, individuals are responsible for their own actions,
which they can examine and control through rigorous self-
discipline.
7. Hamlet Act 2, Scene 2.
8. See Norman Doidge, M.D. The Brain That Changes Itself:
Stories of Personal Triumph from the Frontiers of Brain
Science (2007)
9. See John B. Ardens 2010 Rewire Your Brain: Think Your Way
to a Better Life
6. Probably, or Possibly?
Successful Active Investors Think in Terms of
Probabilities.
You dont want to believe in luck, you want to believe
in odds.
Charlie Munger
We are deterministic thinkers living in
a probabilistic world. We crave certainty about how
things will unfold, which is precisely why we fall for
predictions and forecasts. Yet, even in the most prosaic
of circumstances, nothing in the stock market or in
life is 100% certain. But many people confuse
possibility with probability and the two are almost
exact opposites. Think of Jim Carreys Dumb and
Dumber character Lloyd Christmas. When reacting to
the out-of-his-league Mary Swanson rejected his
romantic advances, she told him his odds were
more like one out of a million. His response, after a
long pause to calculate: So youre telling me theres a
chance. Yeah! Poor Lloyd mistook possibility with
probability, having failed to understand that the
probability of ending up together with Mary was
virtually zero.
If we focus on possibilities rather than
probabilities, we become lost. Almost anything is
possible, even when highly improbable. If we think
only of possibilities, it would be hard getting out of bed
in the morning. Its possible that you will get hit by a
bus, get accosted by a stranger, get killed by a crashing
plane or, more brightly, win the lottery, despite the
very low probability of any of these events occurring.
Focusing on possibilities can lead us to a state of
constant fear thus our craving for orderly, known,
and certain information and actions.
Life doesnt work that way. According to Richard
Petersons Inside the Investors Brain (see our Blogs
Feb-2017 review of his book), When an outcome is
possible but not probable, people tend to overestimate
its chances of occurring. This is called the possibility
effect Emotions in uncertain or risky situations are
more sensitive to the possibility rather than the
probability of strong consequences, contributing to the
overweighting of very small probabilities.
A great real-world example of people thinking in terms
of possibilities rather than probabilities was during the
financial crisis people actually sold out of all their
long-term investments, and I know of at least two
investors who put large sums of cash into their safety
deposit boxes. They were most certainly thinking of
possibilities rather than probabilities.
A study we conducted in 20091 looked at the 50 lowest
10-year returns for the US market since 1871 and
found that the 10-years ending Feb-2009 are the
second lowest in more than 100 years. Importantly, we
looked at what happened after those horrible periods,
and found that the 50 returns over the next 3 to 10
years were all positive. This led us to conclude that the
probabilities were quite high for the market to do well
in the 10-years after Feb-2009.
To succeed, investors need to determine the
probabilities of a certain outcome, and then act
accordingly. Knowing the probabilities gives you a
strong edge over people who dont know them or
choose to ignore them. If you, like legendary card
player and investor Ed Thorp,2can count cards in
blackjack so that you know the probabilities of what
the next card is likely to be, you have an enormous
edge. The same holds true for any number of
professions: life insurance companies use actuarial
tables to predict the probability of someone dying;
casinos use probabilities that allow the house to always
win in the end and colleges and universities rely on
educational tests to determine who gets a spot at their
institution.
In the stock market, I believe the surest way forward is
to look at the long-term results for an investment
strategy and how often and by what magnitude it
beat its underlying benchmark. For example, this
table3 illustrates the results of simply buying the 10%
of large stocks with the highest Shareholder Yield
(dividend yield plus net buybacks) over an 80-year
sample:
Base Rates vs. All Large Stocks (19272009)
Highest-Yielding Decile of Shareholder Yield in Large
Stocks
Over all 961 rolling 3-year periods, you can see that the
top Shareholder Yield group beats other large stocks
81% of the time by an average 3.24% per year. When
you extend it to all 877 rolling 10-year periods, the
base rate jumps to 97%. Now, look at this through the
lens of Dumb and Dumbers Lloyd Christmas: theres a
4-in-5 chance of winning over any given 3-year period.
On the flipside, however, it also informs us that we
have a 1-in-5 chance of losing to the benchmark!
Few investors pay much attention to base rates, and
study after study has shown that when you introduce
any information in addition to the base rate, people
usually ignore the base rate in favor of the often-
useless anecdotal information. Even though the
rational thing to do is bet with the base rates and
accept that we will not always be right, we are forever
rejecting the long-term evidence in favor of the short-
term hunch, even though our probability of being
correct plummets.
We also ignore probabilities when we enthusiastically
buy a story stock that is incredibly expensive the 3-
year Base Rates for buying stocks with the highest P/E
ratios is just 20%, losing 8 of 10 rolling 3-year periods.
Whats the bottom line? Knowing the past odds of how
often and by what magnitude a strategy either
outperforms or underperforms its benchmark gives
you an incredible edge that many people ignore.
Successful Active investors know this and pay close
attention to this information, thereby putting the
probabilities on their side.
7. Discipline
Successful Active Investors are Highly
Disciplined.
Discipline is the bridge between goals and
accomplishment.
Jim Rohn4
It is easy to say is that you are an unemotional,
disciplined investor right up until when the market
goes against you and you throw in the towel. Heres a
short quiz, to help gauge the likelihood of your
actualization:
Did you
sell most of your equity holdings during the
financial crisis?
enthusiastically buy tech stocks in 1999?
ever let a prediction or a forecast influence
your dealings in the market?
blame events or other people for what
happened with your investments?
ever ignore all the evidence and probabilities
and decide to just take a flyer on a stock or a
fund?
ever invest in something because the majority
of other investors were also doing so?
ever abandon a well-tested and well-thought-
out investment strategy because it had
recently been doing poorly?
The upside: If you answered yes to several of these
questions, congratulations! You are a normal human
being. The downside: Chances are, you may lack the
discipline required to succeed as an Active investor.
Being highly disciplined is extremely difficult. It goes
against almost every impulse we have baked into our
genes. Sure, its easy to be disciplined when things are
going your way; when you are significantly
outperforming your benchmark. However, real
discipline is what kicks in when things are going
against you, sometimes significantly. When every week
seems like a month, when you are filled with self-doubt
and constantly questioning every single part of your
investment process, when others express skepticism
about your core beliefs, and even friends and
colleagues begin to doubt you and your process
thats when discipline is required.
And, boy, does your mantra change. You know then
what its like to feel horrible about yourself and your
ideas, and all of a sudden you really understand the
opening of Shakespeares 29th sonnet:
When, in disgrace with fortune and mens eyes, I all
alone beweep my outcast state, and trouble deaf
heaven with my bootless cries, and look upon myself
and curse my fate
Thats when you need discipline, if you are to succeed.
And, like most things in life, thats precisely the
moment when you want to shout: Stop! Every event
and news item you see is the opposite of what you
believe, and your emotions and intellect implore you to
Stop! And every single thing you read or hear people
say just reminds you that you are wrong, that you must
abandon your silly persistence and allow this pain to
stop. Just let it stop. The emotional pain is so
overwhelming that it feels like slow torture, day in and
day out, and all you need do to make the pain go away
is to abandon your silly process and allow yourself to
breathe.
If you continue to stick with it, even when every single
thing conspires to dissuade you from consistently
applying your investment ideas and principles, youll
also know that you may be wrong for a lot longer than
you think you can endure. Whats worse, you wont
have to just put up with your own fear, doubts, and
pain. Instead, youll often be derided, mocked, and
ridiculed by many other people wholl simply think of
you as a fool. All the recent weight of the evidence will
be on their side. Not only that, but experience teaches
that these detractors dont come alone, they come in
crowds. The criticism can be deafening, snide, and
cruel, which can devastate your psyche. According to a
March 22, 2012 article in Psychology Today magazine,
The (Only) 5 Fears we all Share are:5
1. Extinction
2. Mutilation
3. Loss of Autonomy6
4. Separation7
5. Ego-death8
 Each of these also plays a part in feeding your self- 4.
doubt and the desire to abandon your discipline, but 5.
the last 3 Fears (#35) are the cruelest in this instance
because they feed into everything you are feeling at the
6.
time of greatest risk.
For more Rohn-isms, go to jimrohn.com
See psychologytoday.com/blog/brainsnacks/201203/the-only-5-
fears-we-all-share
Loss of Autonomy: The feeling of being controlled by
circumstances beyond our control.

The only thing you can do is hang on to the idea that 7. Separation: The feeling of rejection, (and) not (being) respected
this too, shall pass. Not much of a lifeline, is it? I go or valued by anyone else.
on at length about this because I have been there 8. Ego-death: Fear of humiliation, shameor the shatteringof
more times than I care to remember. Indeed, absent ones constructed senseof capability and worthiness.
discipline, all 6 of the other emotional and
9. See entire post here:
psychological traits (barriers to successful Active AWealthofCommonSense.com/2017/02/where-I-disagree-with-
investing) are worthless. And the question charlie-munger
you mustanswer honestly is: In the throes of
underperformance or rocky market conditions, do I
really have the discipline to remain unemotional and
stick to my plan?

According to a recent post by Ben Carlson discussing

Charlie Mungers ability to withstand drawdowns, he
wrote: Many people simply werent born with the
correct wiring to be so unemotionalThe ability and
willingness to take risk are not always equal for most
investors. Charlie Munger is a [unicorn]. Its good for
investors to remind themselves of this when trying to
emulate him. Very few can.9

I believe that you can do significantly better than

indexing your portfolio passively, IF you possess the 7
traits laid out in this article and you can enforce them
with a disciplined commitment over time. But, as Mr.
Carlson points out, very few of us can.

If you are one of the few, I think our current

environment and the rush of investors into Passive
products will only increase your chance of doing much
better than an index but you must employ these 3
simple tips:

1. Be brutally honest with yourself.

2. Keep a detailed journal of all your investments

and note when you succeed and when you fail.

3. Work on your weak points until they are

eliminated.

If you can manage all this, youll become a member of

a shrinking, and yet potentially lucrative, club. As
youd expect, club membership is limited to long-term,
Active investors.

1. Bookmark: osam.com/10YR-Real-Average-Annual_1871-
present.pdf

2. See Ed Thorps acclaimed A Man for All Markets: From Las

Vegas to Wall Street, How I Beat the Dealer and the
Market (Random House, January 24, 2017)

3. From the 4th Edition of What Works on Wall Street