When I began investing, I always wondered why professionals were so obsessed with finding “cheap stocks” and selling a few months or years later.

To me, it doesn’t make sense to be constantly buying and selling good businesses.

Why wouldn’t I just buy into great companies, like Apple Inc, at decent prices, hold on, and let the company compound my investment over many years?

(Disclosure: I hold Apple shares in the Rask Invest model portfolio. I expect to hold it for many more years to come.)

Curtis Larson, my guest in the latest episode of The Australian Investors Podcast (see below), is a highly analytical thinker and an experienced investor. He told me he has held shares like Apple for many many years. And he’s made many many times his money by doing so.

I know it might sound a little wishy-washy to say that I won’t sell shares after I have bought them. I do sell.

But my approach to investing is not nearly as systematic as many of the investors I interview. I’ll hold shares in a company until I find a better business, for portfolio positioning or if I think I’ll need the cash for something else.

It not only makes intuitive sense, there’s also some good ol’ fashion mathematical proof behind the strategy.

Think about it this way…

When you buy shares, it’s a commonly accepted truth that you won’t get every stock pick right. Peter Lynch, one of the best fund managers of our time, said good investors get 6 out of 10 right.

So let’s say you get 6/10 right, and the share prices increase beyond what you paid. That means your ‘hit rate’ is 60%.

Peter Lynch was right, many investors struggle to achieve a 60% hit rate over a career.

In fact, some highly successful investors have a hit rate below 50%. Meaning, they get more wrong than right.

But how can they be successful if they come up with more bad ideas than good ideas?

Their gain-to-loss ratio is important. As Morphic Asset Management’s Chad Slater (click here for my chat with Chad) wrote in the AFR:

“The gain-to-loss ratio is intrinsically linked to the hit rate. This is how much money is made from the winners compared to what is lost on the losers.”

Typically, investors can make a return of more than 100% when they buy a share in a company but they cannot lose more than 100%.

Imagine you have a portfolio of just two stocks, both were bought at $1.

One of the companies fails (goes to $0). The other triples in price (goes to $3). Behavioral biases like loss aversion tell us that would feel like a loss overall. But the reality is you’re making money, even if your hit rate is 50%.

Obviously, the math is a little more complicated when you have a 20 or 30-stock portfolio. But the underlying strategy is the same: get your winners to outweigh your inevitable losers.

How It Works

Obviously, I’ve made the strategy sound oh-so-simple.

It is simple. But it’s not easy.

Some investors, like The Motley Fool’s David Gardner, have created serious amounts of wealth by using a similar “Rule Breaking” strategy (as he calls it).

Here is my checklist for this type of investment strategy:

  1. You must be a long-term investor (5 or 10+ years). Your investment won’t compound if you don’t give it time.
  2. You need to be humble, have a thick skin and even embrace your losses because you’re going to be wrong, often
  3. You need to be curious and invest time to understand businesses and their products
  4. You need to buy great companies only — not concepts like Bitcoin, some pot stocks, speculative biotechs and miners
  5. You need a plan put in place BEFORE the market tanks, something like dollar-cost averaging (e.g. I will invest $XXX each and every month no matter what)
  6. You need your financial house in order: a reliable income that exceeds household costs, adequate insurance, an emergency cash buffer and more (it could be a wild ride, so prepare yourself)
  7. Diversify widely (don’t bet the house on one idea) or use a core-satellite approach (meaning, you own a larger ‘core’ amount of assets which includes things like low-cost index funds, property, bonds, etc., then you have a “tactical” position in these growth shares)
  8. Finally, you must be prepared to “let your winners keep winning”

That final quote comes from the guest in the most recent episode of The Australian Investors Podcast, Curtis Larson.

Curtis’ strategy is a little different to the one I just described but it’s equally appealing in my opinion. One listener told me on Twitter, “…I found myself nodding my head throughout!”

Curtis’ investment strategy is very similar to my approach for Rask Invest, so I really enjoyed this talk.

Click here to tune into my conversation with Curtis Larson.

Cheers to our financial futures!

Owen Raszkiewicz,
Founder of The Rask Group & Lead Adviser of Rask Invest

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Disclaimer: This article contains general financial advice only and should not be relied upon. Please see The Rask Group’s full disclaimer below.

Disclosure: At the time of publishing, Owen Raszkiewicz owns shares in Apple. This is a disclosure and not a recommendation.

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