Why active investing? Investing path part 3

Is active investing the route for you as a full-time working individual?

December 18, 2020

Snir's investing desk is a newsletter focused on intelligent, value investing for the individual investor. The subjects are evergreen and deals with the essence of investing, mental models, and concepts.

In part 1 of this series, we explored saving money and the implications of inflation and index funds investing.

In part 2, we looked at giving our money to money managers and how it doesn't usually work and explored real estate investing's optionality.

In this last part, we'll examine the active investing path, and personally for me, what led me to choose this as the path for my investing life as an individual investor with a full-time job as a software developer.

When I faced with the decision of being an active investor, I had 4 important questions I needed answered:

  • What is required to be a successful individual active investor?
  • Is it worth it? Can I make returns high enough to compete with the other paths and justifying the time effort?
  • How much time does it require? Can I sustain it while working full time?
  • Can it be joyful for me so that I can be sure I'll want to do it for years?

What is required to be a successful individual active investor?

This question depends on the type of active investing you plan to practice. There is high-growth, dividend-growth, momentum, value, and so much more. Each strategy requires a different type of work.

The investing method that resonated most with me is the value investing style Buffett and Munger. It is the most consistent in terms of long term returns and the calmest method of all.

Going into details comparing different investing methods and proving that value investing is most consistent often merits its own book. Let alone a blog post series.

So you'll have to take a leap of faith with me on the decision to go with value investing.

How I define value investing

For me, it's first and foremost investing like Buffett and Munger. But it is not dogmatic in any way. Value investing, for me, is also investing like Peter Lynch. I also took some hints from Jim O'Shaughnessy, who is considered more of a quant investor.

The short pitch is this: Understand a business well enough to value it within a reasonable margin. Then take an extra margin of safety, and if the price is right - buy.

What does it take?

The question of what it takes is also dependant on the question further down this post - what can I expect?

Expectations of a high return rate might require more work - either on the depth of each company I research or on the number of companies I research for me to get a higher chance of running into great opportunities.

Regardless, the specifics are all serving in properly valuing a company and its prospects.

From the qualitative aspect:

  • Looking for an economic moat
  • Assessing the management
  • Knowing the competition
  • And more and more..

From the quantitative aspect:

  • Reading the financial statements
  • Discounted cash flow analysis
  • Free cash flow growth analysis
  • And again, more..

With this method, I'm open to looking at any company. For example, a high growth strategy limits you to high-growth companies, and a dividend growth strategy limits you to companies with a dividend.

Each type of company might require a different approach and tools to value it. This will lead to an obvious strength in a certain kind of company - but it's ok.

Is it worth it? What returns can I make?

There's no definitive number

This turned out to be a very tricky question. There are so many variables going into it, and it's hard to get a numeral answer and reliably defend it.

It's even harder given the circumstances - I want to invest as an individual investor. Naturally, there is no data available for individual investors' typical performance due to it being private.

Relying on individuals telling me their performance or even showing me their accounts is futile too. I saw close to 50 friends' portfolios - all performed 20%-50% annually in the past few years.

But this is similar to hearing all your friends doing above average at their SATs. The averages and underperformers will keep their results private, that's all.

Taking the leap of faith

Since there is no "provable" number here, I had to take a leap of faith in believing I can make it work with good returns that will justify it.

Specifically, I believe 15% a year compounded is very attainable for the cautious and calculated investor.

It took me hundred of hours of lectures from top investors, a ridiculous amount of books, and even more ridiculous amount of articles, and real-world examples of the practice to get to that conclusion.

In the past 8 years that I'm investing, my results have been much better than this expected 15 %. But I attribute most of it to luck, not skill. The first 15% might be skill. Everything above it is luck as far as I consider it.

Is 15% worth the hassle?

Now that we've got a base number, is 15% a year worth it compared to other investing paths?

Here comes the investor calculator I made to visualize this. Below is the path of index fund vs. active investing with 15% return per year.

investor calculator index vs active

Index fund investing vs. active with 15% return

With active investing, I can comfortably retire at age 52. While utilizing index fund investing will put me in a position far away from that.

This is the power of compounding visualized.

So is it worth it?

If I can retire early or even semi-retire (work only 2-3 days a week on things I choose and like), then it is absolutely worth it.

How much time it requires? is it sustainable with a full-time job?

This question, too, is dependant on the active investing methodology one chooses. I will address the question with my interpretation of value investing described above.

There are 3 parts to the process:

  • Find relevant companies
  • Filter out the obvious bad ones
  • Deep research the promising ones

Each step takes time.

Find relevant companies

I like to follow Buffett, Munger, Lynch, Phil Town, and much more advice on relevant companies: Companies that I have an edge in from either understanding their business sector or from being a consumer.

That does not necessarily mean I know all the companies in a field. Let alone filter out the public companies among them.

A practical example is this: I like video games and have a deep understanding of the field. Relevant companies might be "Activision-Blizzard," which is a large video game producer.

But another company in the field might be Epic, a video game producer and game engine maker, a fundamentally different business.

I might go deeper into this rabbit hole and look at Unity. They are not a game producer but a huge game-engine maker.

What about Valve? They are less of game makers nowadays and more of a platform for distributing games through steam.

You get the point. Discovering companies in your circle of competence is a process that takes some time.

gaming companies

Gaming companies

How much time? I'd count it as.. 0.

You discover companies in your circle of competence merely by living in the world and having interests.

Use this to your advantage. Just be more curious. I don't count this time as part of my investing practice as this is something I do by being a human in this world.

Filter out obvious bad ones

After you got your companies, it's time to do some basic filtering.

This process includes looking at the balance sheet to assess a company's debt situation, looking at the revenues growth in the past few years, measurements like ROIC and Free cash flow, and more.

This process can take anywhere from 10 minutes to 2 hours. Depending on the company and on your experience and skill to spot red flags.

Researching the company

After you finish with basic filtering comes the part of in-depth analysis. In here, you will analyze the company and its field such that you'll be able to assess its intrinsic value to decide whether investing now is a good idea or not.

The time variance here is huge. It depends on:

  • How complex the business is.
    • Coca-Cola is simple. Selling drink concentrates to bottles at a margin.
    • Samsung is complex. Many different models with different approaches and margins. Electronics, consumer electronics, software, finance, and more.
  • How familiar you are with the field.
    • Fields you have already researched before will require much less upfront work than new fields.
  • What do you research.
    • I like looking at financial statements going 10 years back.
    • Comparing the financial performance to competitors.
    • Reading the last three 10k filings, at minimum.
    • Listening to the last 2 quarter calls.
    • And more, and it varies slightly with each company.

In my experience, this research can take anywhere from 2 hours minimum through 6-7 hours in the average case and ends with 15-20 hours in the high end.

Summary - is it sustainable?

I need to research 1 company every 2 weeks. And it is sustainable when devoting a few hours each week for this.

It is more than sustainable. A company every 2 weeks for in-depth analysis? This quickly adds up.

Soon you find yourself with a bunch of companies you are deeply familiar with on your watch list, waiting for the right opportunity to invest in them if they weren't already investable in the first place.

I only invest in 1-2 companies a year, on which I have very high conviction. And it works well.

Can I keep doing this for years?

For me - absolutely. But this is a very individual question.

I like researching companies and learning about their business models and their history. It's pure fun for me.

As I mentioned before, I like video games. This, for me, is the ultimate game. The most complex mechanic, a massive amount of players to play with, and the rewards are great.

I can't see this as something I don't enjoy. So I can't advise those finding it boring - I've never been in that state.

I suggest you'll give it a try and see if you can get enthusiastic about the process. If you can't, I think it will be hard to sustain and highly suggest other routes.