Bookworm: 6 final insights on successful long-term investing

Bookworm explores insights from investing and business writing that I found interesting or useful.

Each insight falls under one of three key principles: owning high quality assets, fostering a long-term mindset, and putting process over emotion.

A quick announcement

In June my partner and I learned that we have a baby on the way.

We wanted to give parenting a crack in Sydney, but eventually we came to our senses and decided to move back to the support network we have in Scotland.

As a result, my time at Morningstar is coming to an end and this will be the final Bookworm.

I thought it made sense to revisit some of my favourite insights related to the three investing principles promoted in this column. Let’s start with why I chose these principles in the first place.

High quality, long-term, deliberate.

There are a thousand different approaches you can take to investing. At Morningstar, we recommend you take one aligned with the financial goal you are trying to achieve and the edge you are trying to exploit.

This is where Bookworm’s three principles – seeking high quality assets, fostering a long-term mindset, and putting process over emotion – came from.

They reflect how I want to invest given my goal of funding a happy retirement 30-plus years from now. They also reflect the only edge that I have a chance of exploiting versus professionals.

As an individual investor, I have no career risk. I am not investing my portfolio to keep up with the market, competitors or client expectations. I am only investing it to reach my long-term financial goal.

I want to invest in a way that leans into this edge and actively avoid behaviours that extinguish it. The biggest key here is investing in a truly long-term manner rather than trying to achieve the best results every quarter or even every year.

Let’s go a little deeper into each of the three principles.

What is a quality asset?

If we want to invest in ‘high quality assets’, we need to be able to define what quality means to us. In several editions of Bookworm, I went looking for how some well-known investors define it.

The approach I found most interesting was Marathon Asset Management’s use of capital cycle analysis, as fleshed out in their excellent books Capital Account and Capital Returns.

Instead of trying to forecast demand, Marathon try to gauge how the ‘supply side’ of an industry will be affected by flows of capital in and out of it. And, in turn, how this might affect future profitability and returns on capital within an industry.

Marathon originally used this to unearth companies and industries primed for an improvement in profits, returns on capital, and market valuation. But they soon realised that it was useful in a different way.

Marathon came across a small group of companies where profits and returns on capital were seemingly immune to this cycle. This immunity and, more importantly, the characteristics underpinning it highlighted businesses of exceptional quality.

This isn’t a million miles away from how Morningstar view business quality through our Moat framework. We are looking for companies with some kind of structural and durable protection from capitalism’s most defining characteristic – competition.

We point to five sources of protection: cost advantage, switching costs, network effects, efficient scale and intangible assets. In other chapters of Bookworm, I looked at why Terry Smith likes intangible moat sources and why Phil Fisher prefers cost advantaged firms.

Getting clear on what quality means to you can help you build the confidence you need to commit to an investment for several years if not longer. This brings us to my favourite insights on fostering a long-term approach.

Embracing the uncomfortable

One of my biggest a-ha moments as an investor came in the last few weeks of writing this column. I realised that to get extraordinary long-term results as an investor, you must accept realities that other investors cannot accept.

I realised this while reading old shareholder letters from Warren Buffett and the late Marty Whitman. Both men regularly made the same thing clear to their investors: a portfolio cannot reasonably be expected to outperform the market or its peers every single year.

What’s more, trying to invest in a way that chases this can be counterproductive.

Giving up on the notion of outperforming every year opens up the possibility to optimise for long-term results instead of short-term ones. And if equities are the right asset class for your goal in the first place, it is likely that the long-term result matters a lot more.

How might embracing the uncomfortable look?

Committing to an investment in the same company for many years definitely counts. Why? Because rough patches during a holding period that long are absolutely guaranteed, and many investors simply cannot handle the thought of that.

There are going to be times when business isn’t as good, markets aren’t impressed, and the stock gets slammed. Or there may be times when things have been going well and you are tempted to take profits before the party ends.

I have previously called this the fear of not selling the top and the fear of not catching the bottom. Both stem from a short-term performance mindset of the kind that I actively try to avoid in order to lean into my potential source of edge.

At a higher level, committing to a certain investment style or strategy also counts as embracing the uncomfortable. Because, again, it is virtually impossible that any one approach to investments will avoid periods of underperformance.

Take a look at Bookworm chapter 20 to see how accepting periodic underperformance helped Buffett and Whitman outperform.

Or read chapter 21 to see why selling a company with good long-term prospects at a bad time can be so costly.

Protecting your returns from self-harm

Charlie Munger famously quipped that in investing “you make the most money by sitting on your ass”.

Munger was referring here to the power of letting a wonderful business (and your investment in it) compound in value over time. The opposite is also true.

Investors risk losing most money when their emotions –excitement, fear, or fear of missing out – compel them to buy or sell without thinking it through in the context of their strategy.

These emotions can lead an investor to “buy high and sell low”. They also make it a lot harder to pursue a truly long-term strategy. Why? Because holding on is a lot harder when the initial purchase wasn’t properly thought out.

My early investing years were full of self-sabotage of this nature. Especially in my shameful year of “investing” in 2021. Joining Morningstar and being immersed in the ‘investing over investments’ mindset has helped me immeasurably.

I explained this difference in Bookworm chapter 19, an edition written in July while I was in Scotland visiting family. At the time, I thought I wouldn’t be home again for a couple of years. How wrong I was!

In that edition I used the example of golf, where most amateurs (including me) spend their practice time poorly, to suggest a better approach for investors. The approach? Spend more time thinking about why and how you invest, as opposed to always thinking about what you can buy next.

Keeping the big picture in mind – your goals, strategy, and potential edge – can help ensure that every trade is more thought out, more in-fitting with your strategy, and easier to stick with for the long haul.

A simple hack for staying on course

The act of writing your investment approach down on paper can make it a lot easier to put processes over emotion.

At Morningstar we call this laying out your Investment Policy Statement, and you can read a full guide to the different components of it here.

We want our strategy to reflect our goals, and we want our behaviour to reflect our strategy.

Every time you are tempted to buy or sell something, simply compare the action to your Investment Policy Statement and see if it fits.

The next chapter

I hope you’ve enjoyed Bookworm and my other writing for Morningstar. More importantly, I hope it has helped your efforts to build a better future for yourself and those you love.

For more real-life perspectives and strategies on doing this, I have one final book recommendation to make. My colleagues Mark and Shani have co-authored Investing Your Way, which outlines the (very) different journeys they have taken to building wealth.

The book comes out on October 6 and has climbed up Amazon’s personal finance charts even before its release. The book wasn’t written to rack up accolades though. It was written to help you find a path to financial freedom that truly works for you.

If you’d like to read it as soon as it comes out, you can pre-order a copy on Amazon or at Booktopia today. It would probably have made for a great edition of Bookworm, alas the universe had other plans. Thank you for reading!