4 investing principles, by William J. Ruane (Sequoia fund)

In a rare interview with the late W.J. Ruane, financial author William Green learned about his four guiding principles of investing. Ruane acknowledged having learned these simple rules from Albert Hettinger in the late 50′.

THE FOUR GUIDING PRINCIPLES OF INVESTING

1) Do not borrow money to buy stock (don’t use leverage). You don’t act rationally when you are borrowing money.

2) “Watch out for momentum”. Proceed with extreme caution “when you see markets going crazy” either because the herd is panicking or charging into stocks at irrational valuations.

3) Ignore market predictions. “I firmly believe that nobody knows what the market will do…”. The important thing is to find an attractive idea and invest in a company that’s cheap”.

4) Invest in a small number of stocks that you have researched so intensively that you have an informational advantage. However, for regular investors, there is a safer path to success. Most people would be much better off with an index fund. But for investors aiming to beat the market, concentration struck him as the smart way to go.

COMMENTS

William (Bill) Ruane, class 1925, was one of the most successful stock pickers of his generation. When Buffett closed his investment partnership in 1969, he recommended Ruane as a replacement for himself because they both invested using Ben Graham’s value investing principles. The company’s Sequoia Fund, a mutual fund that has substantially outperformed the Standard & Poor 500 index since its inception in 1970, has been so successful that it closed to new business in 1982. It only reopened to new investors in 2008.

I find Ruane’s first three principles crystal clear. Indeed, I don’t find qualified content that questions these points. The only controversial principle could be the fourth one. Ruane himself opens to two different options and “schools of thought”: investment concentration or investment diversification. Even Warren Buffett has praised both approaches on several occasions: while Ruane and Buffett both defend the superior practice of value investing and stock picking (concentration of investment on a few stocks), they acknowledge the practicality for the “average/regular investor” to avoid the risks of concentration and stock picking by diversifying using index funds.

For me, it is important not to wrongly dismiss the meaning of Ruane’s “regular investor” or Warren Buffett “average investor”. As Jack Bogle once explained, “you don’t need to be great” to thrive as an investor. Indeed, you don’t need to beat the market to do well.

There is something exciting about the idea of beating the market. I get it. However, the simple truth is that “being the market”, riding the market, already provides you with excellent investment results in the long term. In addition to that, financial data proves that most professional and retail investors trying to beat the market by stock-picking fail and underperform the most popular market benchmark (the S&P 500).

That’s why, after all,  I strongly believe in investing using a well-diversified portfolio of index funds.

Until next time, Sweat Your Assets.

RECOMMENDED READING 

– There are only three ways to Beat the Market, by Charles Ellis

– You Should not Try to Beat the Market