I spent time searching for the answer to this question: Why do the majority of individual investors under perform the market over a 20 & 30 year period?

A Forbes article reported these sad facts:

According to the latest 2014 release of Dalbar’s Quantitative Analysis of Investor Behavior (QAIB), the average investor in a blend of equities and fixed-income mutual funds has garnered only a 2.6% net annualized rate of return for the 10-year time period ending Dec. 31, 2013.

The same average investor hasn’t fared any better over longer time frames.  The 20-year annualized return comes in at 2.5%, while the 30-year annualized rate is just 1.9%. Wow!

I now realise that I’ve been asking the wrong question, as I should been asking: What does the learning process of the individual investor encompass?

“The road to success is not easy or else everyone would be the greatest at what they do—we need to be psychologically prepared to face the unavoidable challenges along our way, and when it comes down to it, the only way to learn how to swim is by getting in the water.”

Josh Waitzkin

In the first 5 years of investing my own money, I thought my returns were mainly due to luck as I had earned 34% annualized returns.

Now, luck is a major contributor in the short term (0 –24 months). But to sustain these returns requires more than luck, over the long term, skill becomes the dominant factor.

And if you are choosing an investment fund, one requirement is a track record of exceeding the market return, of at least 3 years, returns in-excess of the market under a 3 year period should be put down to luck.

I was quite lucky when I started my investment journey, something I wasn’t aware of at the time.

My early schooling experience contributed to my unique ability to cut through complexity, which allows me to focus solely on the essential principles involved in investing.

But I was not a top student, I wouldn’t consider myself in the top half. I struggled through my early schooling years, I was held back a year during primary school.

I received a lot of support from my teachers, they were encouraging, and for which I’m grateful for.

During this time I had to develop, with assistance, a unique learning process that ended up pay dividends for years to come.

I always considered myself average, never smart or intelligent, and my early schooling years certainly contributed to this self-perception.

The small but significant difference that separates the top investors who outperform the market consistently, from the investors who consistently underperform the market, is not their investment techniques or unique investment insights, they certainly contribute to their superior returns, but it comes down their individual learning process.

Investment is more art than science, there are numerous examples of men with formula’s who went on to crash spectacularly throughout history. (Read the book: When Genius Failed: The Rise and Fall of Long-Term Capital Management, by Roger Lowenstein.)

Simply having the mechanical techniques to invest rationally is not the key factor in earning superior returns.

Investing is a lifelong journey, there are two things that bring it to an abrupt end; an absolute loss, or, the investor’s own impatience with the investment process.

Both are intertwined with each other.

Hence, why Warren Buffett says the following: “The first rule is not to lose money, and the second is to observe rule one.”

The vast majority of motivated individual investors, young and old, make terrible mistakes during their investment approaches. They fall frustrated by the wayside while those on the road to success keep steady on their paths.

It is this impatience with the investment process that I’d like to talk with you about.

During my early schooling, I explained how I struggled with school and how the teachers were very encouraging, and it was this encouragement that helped me develop my own learning process.

We are taught at school to focus on results at an early age, there are the weekly spelling tests, the math’s tests and even homework is marked with a score, and don’t forget the yearly grade-book that you’d desperately hoped parents would not receive.

We begin to judge ourselves and our peers based on these scores. Your friends, family, and teachers will call you “smart” if you top the class for Mathematics, English or Science, for instance.

Have you also noticed that most investors are focused on achieving specific returns, whereas the great investors do the opposite, they are focused on the investment process.

This plants that small seed, a seed that is referred to as “entity theorists” by psychologists.

Dr. Carol Dweck a leading researcher in the field of development psychology, has found that Children who are “entity theorists” — that is, kids who have been influenced by their parents and teachers to think in this manner, and we’ll call it the fixed mindset — are prone to use language like “I am smart at this” and to attribute their success or failure to an ingrained and unalterable level of ability.

They see their overall intelligence or skill level at a certain discipline to be a fixed entity, a thing that cannot evolve.

Whereas, Incremental [fluid] theorists, who have picked up a different modality of learning — let’s call it the fluid mindset — are more prone to describe their results with sentences like “I got it because I worked very hard at it” or “I should have tried harder.”

A child with a fluid theory of intelligence tends to sense that with hard work, difficult material can be grasped, step by step, and the novice can become the master.

The subtle differences in feedback can lead one child down the fixed mindset path and another down the fluid mindset path.

“Congratulations, You’re, so smart” cries one parent – no matter how well intentional the message – plants the seed of a fixed mindset into their child’s mind.

And, I’ve heard a mother say to their daughter, “don’t worry I wasn’t good at math’s either, girls aren’t good at math’s,” the child now associates success or failure to ingrained talent, something that is outside of their control.

Whereas, the parent that says; “If you study a little harder for the next test and you’ll do great! And feel free to ask me for help, I’ve been there before,” teaches the child that with just a bit more effort – study – she would have passed the test, thus associates success or failure to the amount of hard work.

So how does this affect individual investors in their investment process?

“The key to pursuing excellence is to embrace an organic, long-term learning process, and not to live in a shell of static, safe mediocrity. Usually, growth comes at the expense of previous comfort or safety.”

Josh Waitzkin

I was lucky to have received encouragement and not praise for putting in the work, at primary school. Carol Dweck has a book called I recommend you read.

Both mindsets are not fixed. This is important, as you go from fluid to a fixed mindset and not noticed it until a significant event occurs jolting you out of your arrogant state.

This may also help explain the research finding that fund managers born into low or middle class families consistently outperform their peers who grew up in a privileged family. Source.

The individual investor who is consistently persisting will have internalised the fluid mindset. They internalize their losses and turn them into lessons.

The losses are still painful, having a fluid mindset doesn’t ease the pain. But they have a system in place for when it occurs to lessen its impact and draw out the lessons.

“In my experience, successful people shoot for the stars, put their hearts on the line in every battle, and ultimately discover that the lessons learned from the pursuit of excellence mean much more than the immediate trophies and glory.”

Josh Waitzkin

This is where a coach becomes invaluable. 

If you are going to grow, move from one investment level to the next, requires you to be in a vulnerable state.

Think of it like a crab changing sea-shells.

A crab during its life will need to change sea-shells a number of times.

The sea-shell provides protection from prey, but to grow it has to change to a larger shell, which requires it to become vulnerable to prey eating it during the search for a bigger shell.

The crab is like an investor in a fluid state transitioning from a good investor to great investor.

Unlike the crab, a coach can provide the support and protection to an investor during this transition period.

“If the principles become dated, they’re no longer principles.”

Warren Buffett

Warren Buffett has moved from the small sea-shell that only accommodated the ideas of Benjamin Graham and moved, with help from Charlie Munger, into a larger sea-shell that accommodated both investment ideas from Phillip Fisher and Benjamin Graham.  

The investment process is intertwined with the Learning Process.

I become inspired when I read Robert Pirsig’s Zen and the Art of Motorcycle Maintenance, as at the same time I was experiencing internal roadblocks that were slowing down the learning/investment process. 

Pirsig was describing the process of fixing a motorcycle and how in the process things always come up, a nut will get lost, or a low-quality part get easily damaged during removal.

These unanticipated things can drain you of your enthusiasm, leaving so you discouraged, you want to quit.

Pirsig called them gumption traps. Gumption is word Pirsig refers to when a person is filled with enthusiasm, they are ready to tackle the unknown.

At the time I was reading this passage, I was experiencing my own gumption traps during the process of reading an unfamiliar company’s annual report.

If you are reading an annual report for the first time about a company in an industry unfamiliar to you, then you will begin to understand the inner road blocks.

Reading the CEO (and/or Chairman’s) letter presented many external gumption traps.

One such gumption trap is the use of excessive industry jargon that interrupts your reading, requiring you to search for each word’s unique meaning, and all the while leaving you questioning the use of such words, are they deliberating trying to confuse shareholders?

But it is the inner gumption traps that will derail us (off the quality tracks).

One particular inner gumption trap Pirsig writes about is what he calls ‘value rigidity’. 

“This inability to revalue what one sees because of commitment to previous values. In motorcycle maintenance, you  must rediscover what you do as you go. Rigid values makes it impossible.”

Robert Pirsig

A typical situation occurs when new underlying economic principles are at play.

The facts are there but you don’t see them. You’re looking right at them, but they don’t have enough value.

Pirsig is making a point about how value and quality create the subjects and objects of the world, but for our purposes, and without getting bogged down in book's narrative, we'll assume that value is the preconceived ideas we view the world through to make sense of it.

“This shows up with premature diagnosis, when you’re sure you know what the trouble is, and when it isn’t, you’re stuck. Then you got to find some new clues, but before you can find them you’ve got to clear your head of old opinions. If you are plagued with value rigidity you can fail to see the real answer even when it’s staring you right in the face because you can’t see the new answer’s importance.”

Robert Pirsig

I love the example of value rigidity Pirsig’s refers to as the Southern Indian Monkey Trap.

The trap consists of a hollowed out coconut chained to a tree or stake. The coconut has some rice inside which can be grabbed through the small hole. 

The hole is big enough so that the monkey’s hand can go in but too small for his fist full of rice to come out.

The monkey reaches in and is suddenly trapped – by nothing more than his own value rigidity. He can’t revalue the rice.

He cannot see that freedom without rice is more valuable than capture with it. The villagers are coming to get him and take him away. They’re coming closer.

All he has to do is open his hand and he is free. But how is he going to discover this fact?

By removing the value rigidity that values rice over freedom.

There are two hollowed out coconuts that investors get constantly their hands stuck in, the first is the disposition effect, where we will sell our winners but hold onto our losers, as Peter Lynch’s advised: “You won’t improve results by pulling out the flowers and watering the weeds.”

The second hollowed out coconut traps our thought process in a time capsule.

From the mid 1970s to late 2000s, the majority of investors could not understand how tech companies like Microsoft, Google, and Amazon could grow earnings and cash flow at such astonishing rates over such a short period of time.

They further believed that tech companies were constrained by the old economic forces that past industrial companies were constrained by – diminishing returns, lots of competition and low profit margins.

These old models trapped investors, they could not conceive the idea that a company could capture the majority of a market by initially giving away their service for free (but keep in mind that the first mover (advantage) doesn’t guarantee profits).

Once a tech company comes to dominate an industry, it has the opportunity to earn high returns on capital and high profit margins. This occurs due to increasing returns and network effects.

Buffett said “I blew it,” and admitted that he had the intel to understand Google’s potential for growth early on.

Buffett went on to say that he should have known early on that Google was going places. He remembered that Berkshire subsidiary Geico was paying $10 or $11 to Google every time someone clicked on an ad.

He admitted to being amazed that the business was able to make additional money with no incremental cost. Buffett recognised that the cost of an extra person clicking on a Geico ad was next to nothing for Google.

These incremental costs had become insignificant for tech companies, as the number new users rise. (To read why, check this page here).

These new models were right in front of investors, like Buffett, who had trapped themselves in a hollowed out coconut by clinging tightly to old ideas.