There won’t be any technical jargon or tricky concepts in this week’s letter.  Mom, you should be able to get through this one no sweat.  Stay focused, though, because today we’re going to talk about the single most important lesson for investing success.

I’m not kidding!  Read on…

You can’t always get what you want

I’ve only been working in finance for about a decade, so I don’t have the amount of hands on experience that my elder peers in this industry do.  But a decade is long enough to learn a thing or two, and certainly long enough to understand that while I’ll spend the rest of my life in this business, I will die knowing far, far less about the markets than that which I was yet to learn.  Maybe you feel the same way about your own profession.

Since childhood, when I read off commodity prices from the Wall Street Journal and my dad plotted each little point in his black chart book, I’ve wanted knowledge from the markets.  But over the years an odd thing happened: the more I learned, the more I realized there was to learn, and the deeper that want for knowledge became.  It was like drinking sea water.  Somewhere along the way I passed out.  When I woke up, Mick Jagger’s voice was strutting out of my speakers.

You can’t always get what you want But if you try sometimes You just might find… You just might find You get what you need-The Rolling Stones

It’s very rare that anybody gets what they want out of the markets.

In my experience, what they usually want is money.  But sometimes the want goes a little deeper.  There are people who want to trade the markets because it’s exciting, or to fit in at the club, or because that’s where the action is.  Every once in a while I’ll come across someone who just wants to feel plugged in, something that makes him feel a little sexier at home and with his friends.  As with so many of our desires, it seems to always be about a deep want to be loved by others.  It just manifests on the surface as lust for money.

Instead, what investors ultimately get – unless they’re really lucky, which, trust me, is one of the least appreciated factors amongst amateur investors – is something they didn’t want at all.  Usually they get losses.  They wind up getting burned.  And instead of feeling excited and sophisticated, they feel ashamed or riddled with anxiety.

Will their family still love them if they lose half their retirement savings?  How about their friends at the club?  It’s a touchy subject.  There’s a reason we are quick to boast about that bank stock we bought that doubled in value, but keep those countless stories of loss behind lock and key.  Listening to your friends, you’d think only winners come back from Vegas.  We Nevadans know that’s not the case.

The reality is that amateur traders who actively play in the markets tend not to do so well over time.  This fact is a perfectly reasonable thing to assume and requires no convincing; skill and success are correlated everywhere one looks.  Most of these amateurs that go into the markets are even perfectly reasonable individuals, yet despite this knowledge they are not dissuaded.  They plunge in head first, confident of success.  Why they do it, I am not sure.  Apparently they want something very badly.

It’s not always tears and frustration from the start.  A lot of times these amateurs meet with early gains.  Anybody who simply bought stocks in the last year is probably feeling like a pro.  Your shifty brother in law was also a pro, day-trading dot-com stocks back in 1999.  But he doesn’t day-trade anymore, does he?

Most of the time these early gains are parlayed into eventual losses, or at best, mediocre gains.  I wish it wasn’t this way, that it wasn’t so much like a Discovery Channel documentary where the powerful lion eats the defenseless wildebeest, but it is.  More often than not, amateur money ultimately gets taken by professional firms like ours and others like us.

Now, lions aren’t invincible, and I’ve seen my fair share of professional traders gunned down over the years.  In nearly every occasion they had it coming, taking too much risk or being too lazy in the savannah sun.  Lions may have advantages, but it’s still a dangerous, wild world.  One of my lifelong dreams is to visit South Africa and Botswana.  I want to stand on the edge of the bush and see if I feel that same flutter in my stomach – that mixed feeling of excitement and dread – that I get when I come into the office every day, turn on Bloomberg, and start hunting for trades.

And this certainly isn’t to say that novices can’t become pros.  They can.  But like any other endeavor, it requires years of hard work and lots of self-discovery.  Investors should not expect that simply watching Cramer or attending a VectorVest seminar will transform them into a pro.  I’ve spent my entire career in finance and I still consider myself a cautious young cub.  Ten years from now I doubt much will have changed.

Reading our insignificant little newsletter isn’t going to make you a pro, either.  Our goal here at this newsletter is simply to help you avoid some rookie mistakes, to keep the big picture in mind and not get swept up in the emotion of it all.  If we can give you a tool here and there that helps you be a better investor, all the better.  But I really don’t expect any of that to stick, certainly not every week.

Honestly, the best I can hope for is that we make you think.

I keep a wide perspective on here and talk about all sorts of seemingly random stuff, from sine waves and black holes to Korean cinema and The Rolling Stones.  This stuff is all connected, all part of the same tapestry.  Thinking about the same old things in new ways makes this interconnectedness more clear.

You get what you need

OK, so investors don’t always get what they want.  But I’ve found they usually get what they need.

And just what is it that investors need?

It varies, but nine times out of ten what they need is an education.  It’s tough to learn about the markets if you aren’t in them, and the bad news is that it’s a hard knock life.  This is a business where one learns by doing, and occasionally, the independent-minded amateur will learn enough to get by on their own.

Usually they’ll learn enough to stay away, that the markets are not for them and should be left to the professionals.  And this is a perfectly noble lesson to learn.  It saves them from a lot of pain further down the road.  Last spring I built a garden box for the backyard.  It came out ugly and uneven but I was quite fond of it nonetheless.  However, the valuable lesson was that spending a ton of money on fancy materials or quitting my job to become a woodworker was a bad idea.  If I ever need a nice garden box it will be far cheaper for me to just buy one.  Or I’ll have to ask Kyle, who’s much more handy with a saw than I.

A big part of the education that some amateurs get is humility.  I cannot tell you how many gigantic egos I’ve seen come into the markets, egos that were inflated by tremendous success elsewhere in life.  These individuals assume that the skills that powered their earlier success will translate to the markets.  If there’s one thing the markets are good at, it is crushing egos.  These intolerable folk need reality checks and I’ve found that the market is quite good at giving it to them.  It’s not what they wanted, but even these big egos will occasionally admit it was what they needed.

Sometimes the need goes a little deeper.  There are some people who absolutely thrive on competition and what these folks need is a worthy opponent.  I’ve found that guys like this understand defeat much better than others.  When their portfolio gets battered by the market, they wipe the blood from their lips, learn what lessons they can, and hop right back into the ring.  These are the guys who make and lose fortunes over their lives and keep pushing ahead, undeterred.  Every fighter needs something to fight.

Other individuals harbor a bottomless love of puzzles and live to work out solutions to problems.  I am most fascinated by these folk.  They are cerebral little buggers and I enjoy listening to them talk about the markets.  These are the rare birds like Richard Russell and John Mauldin.  Their approach and commentary is far less dogmatic than what comes out of the major investment houses, and I think that’s because they understand that the whole thing is a work in progress.  They seem to know that they’ll spend their entire lives trying to solve the puzzle of the markets and won’t ever get there.  No bother.  What they live for is the process.

To a certain extent, I can relate to these guys.  Every once in a while my wife and I will buy a puzzle and empty it out on the coffee table.  I enjoy sorting the pieces and my excitement peaks as the edges begin to emerge and seemingly-unrelated big blocks of pieces are joined together.  She loves the sense of accomplishment at the end, dropping the last few pieces into place.  She’ll even leave the completed puzzle on the table for weeks until my pestering to tear it apart grows too obnoxious for her to bear.

And then there are those people that need a vast, intricate social network.  These natural extraverts need to be around and connected to others to feel alive.  This network of people and activity gives them the fuel they need to get through the day.  True, these networks are found elsewhere, but the markets are global.  No other networks are as big and complex.  Maybe these individuals originally come into the markets because they want to make some money, and whether they do or do not, they wind up staying because it feels like home.

Herein lies the secret

We’ve never done it before, but each one of you who have read this far into the newsletter has a homework assignment.  Yes.  Homework.

But you might enjoy it: I want you to go home today and think about what you want from the markets, what you want from your investments.  It’s probably a very simple want, right?  I want them to go up!

 But is it really that simple?  Is sending your child to college what you really want?  Is it a new BMW?  Hopefully it’s not next month’s rent.  Reflect on your past experiences as an investor – professional or amateur – and think about whether you got what you wanted or how often your wants were satisfied.

Then go a little deeper and think about what it was you really needed.  It was probably an education, and given the recent past, you probably got a good one.  Be proud of that.  Even if it involved losing money.  Or maybe it was something else?  What need was it that ultimately got fulfilled?  Or are you not even sure what it was you needed?  Are you still figuring it out?

The first and most important step to take as an investor doesn’t involve investing at all.  It is a journey of self-discovery. Take an honest look inside yourself and try to come to terms with what you find.  It isn’t always pretty.  We tell our investors that the more they understand about who they are as individuals, the better investors they’ll make.

There’s a reason for this.  Someone who understands who they are will make investments that suit that their personality.  And when they have investments that suit their personality they will relate to them on a more intimate level.  They’ll make better decisions and will be more apt to do the right thing at the right time.  They’ll also sleep better at night.  Like sleeping in a bed that was designed exactly for them.

That might sound really nice, but out in the real world it’s the minority case.  A more common example is the guy who is in truth rather risk averse but buys an equity index fund anyway.  Maybe his broker or Jim Cramer or Niles Wealthypants down at the club told him to.  When the stock market has a nasty correction, as it does with disturbing regularity, this guy panics and makes an emotional decision.

In the world of investing, emotional decisions are the worst kinds of decisions to make.  Why did he buy that index fund in the first place?  Did that commitment to “being in it for the long run” wind up being half-assed?  Or did he think he’d be able to identify the top and sell?  Little did he know, he would have been much better off finding a different investment altogether.

This weekend, spend some quality time thinking about wants and needs.  The weather looks like it will be pretty nice here in Reno, so go out in the backyard, lay down in the hammock, and take a little journey inside.  Rock out with some Rolling Stones if you have to.  I’m sure there’s at least one or two of you aging hippies out there, so go on ahead and light up a bowl and see what sort of deep realizations of self you come to.  You have my blessing.  Write that stuff down though, in case you forget.

What I need

As for me, I was sort of forced to do all this long ago.  I needed an edge over my more-experienced peers and thought this kind of alternative approach could help me survive out on the savannah.  It did.  It gave me the right psychology to approach the market and helped me make decisions that were appropriate for me.  I discovered that I’m a value hound and I’m obsessed with framing return in the context of risk.  I like stuff that offers the best bang for the buck.  I share this with you not because I think you’re interested, but because you need to understand the perspective behind the rickety pulpit that this commentary is delivered from.

I gravitate towards things like hedge funds that tend to offer better returns and lower drawdowns, or investments like TIPS that may only return a couple percent but carry zero risk and give me guaranteed protection against inflation.  I pass on the stock market, and get my equity exposure through more resilient stocks that offer good dividends and “alternatively managed” mutual funds.  Or I’ll get it through our own trading.

Good bang for the buck doesn’t always mean cheap.  It means that the relationship of benefit and cost is appropriately balanced.  I love my Toyota 4Runner, which cost over twice as much as a Suzuki Grand Vitara (JD Power’s worst in class).  Despite being more expensive, I thought it was a much better value.  Would I get a similar increase in quality by paying twice as much again and driving away with a Range Rover?  I didn’t think so.  Econ wonks know this territory as the “efficient frontier.”  I look for investments that seek maximum return for a given level of risk, or alternatively, minimize risk given an expected rate of return.

Every once in a while an investor will call and tell me that my old man was the same way.  Naturally, I smile and wonder if that sort of thing is genetic.  Or maybe it was subconsciously built between the two of us at the kitchen table, poring over the Wall Street Journal and recording the relevant bits in that black chart book.

It’s tough to know for sure.  I suppose that’s part of the knowledge that I want, and I’ve accepted that I may never get it.

At this point you might be wondering what it is that I need from the markets.

I think I just need a way to feel connected to my past.