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Monday 19 December 2011

Margin of Safety - The most notable quotes from Seth Klarman's investment classic - part III

I just finished re-reading Seth Klarman's "Margin of Safety". This time I made notes of all the important lessons from the book. This is the last and concluding post of this series. Read them at your leisure. In it is some of the best wisdom on the stock markets from a person who is a "Investment-Hall-of-Fame" life-member.

Part I
Part II

On Portfolio Management

An investor's portfolio management responsibilities include maintaining appropriate diversification, making hedging decisions and managing portfolio cash flow and liquidity.

For the many investors who prefer to remain fully invested at all times, it is easy to become complacent, sinking or swimming with current holdings. "Dead wood" can accumulate and be neglected as losses build. By contrast, when securities in a portfolio frequently turn into cash, the investor is constantly challenged to put that cash to work, seeking out the best values available.

There is nothing inherent in a security or business that alone makes it an attractive investment. Investment opportunity is a function of price, which is established in the marketplace.

Some investors buy and hold for the long term, stashing their securities in the proverbial vault for years. While such a strategy may have made sense at some time in the past, it seems misguided today. This is because the financial markets are prolific creators of investment opportunities. Investors who are out of touch with the markets will find it difficult to be in touch with buying and selling opportunities regularly created by the markets. ... Being in touch with markets does pose dangers, however. Investors can become obsessed, for example, with every market uptick and downtick and eventually succumb to short term oriented trading. There is a tendency to be swayed by recent market action, going with the herd rather than against it. ... Another hazard of proximity to the market is exposure to stockbrokers. Brokers can be a source of market information, trading ideas and even useful investment research. Many, however, are in the business primarily for the next trade. ... Never base a portfolio decision solely on a broker's advice, and always feel free to say no.

On Trading
The single most crucial factor in trading is developing the appropriate reaction to price fluctuations. Investors must learn to resist fear, the tendency to panic when prices are falling and greed, the tendency to become overly enthusiastic when prices are rising. One half of trading involves learning how to buy. In my view, investors should refrain from purchasing a "full position" (the maximum dollar commitment they intend to make) in a given security all at once. Those who fail to heed this advice may be compelled to watch a subsequent price decline helplessly, with no buying power in reserve.

Evaluating your own willingness to average down can help you distinguish prospective investments from speculations. If the security you are considering is truly a good investment, not a speculation, you would certainly want to own more at  lower prices.

Decisions to sell, like decisions to buy, must be based upon underlying business value. Exactly when to sell - or buy - depends on the alternative opportunities that are available.

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