There are so many different parts of life where building strong habits can be extremely effective. Eating healthier foods, getting a better night’s sleep, taking general care of our bodies, and staying hydrated are just a few of the ways we work on our “personal hygiene.”
There is not a single health expert that would dispute the benefits of taking the actions mentioned above. But, for better or for worse, we are responsible for taking care of much more than just “our person.” We, as active investors, are also responsible for our investor hygiene. Developing good habits as an investor, ultimately, will be key for delivering the sort of financial outcomes we need.
Investor hygiene, as described by Jake Taylor, is “the habits, the mindsets, and the kind of environments that you craft that will hopefully lead to the best investment outcomes.” In this case, the ‘best’ investment outcomes will require not only finding ways to make more money, but also finding ways to effectively manage your exposure to risk.
Ever since finishing college, Jake Taylor began learning from one of the most esteemed investors the world has ever known: Warren Buffett. Using Buffett’s meticulous approach to the market, attention to deal, and commitment to “value-driven” investing helped Jake learn more about how to effectively accumulate wealth and develop his own approach.
Now, of course, Jake does much more than simply try to replicate the “oracle of Omaha.” Nevertheless, using Berkshire Hathaway’s founder as a model for investor hygiene helped him find an effective place to get started.
In the investment world, there are some things you can control and others you simply cannot. When preparing an investment strategy, Jake asks himself, “What can I do to make sure that I am in the peak condition to make investment decisions? What can I control to ensure the decisions I make are being made in the best space possible?”
Of course, this starts by taking care of your personal, physical, and mental health. But it also involves using a carefully crafted approach to the broader market. For Jake, this means diligently breaking down each of the decisions that he makes.
“The first decision that you make is whether you want to buy or sell something. That’s pretty simple. From there, the second decision is how you are going to allocate your wealth, whether this means using cash, rearranging your portfolio, or anything else.”
Having good investor hygiene does not mean that every investment you make is going to be profitable. In fact, it is entirely unrealistic to expect this to be the case. But what investor hygiene does require is having a rational reason to make a specific investment. Looking closely at the data, undoubtedly, can help. Looking closely at the balance sheet and diving into a large “population” of data points will inevitably be a much more hygienic approach to the market than making decisions as a result of sheer, unadulterated emotion.
Keeping this mindset helps make it easier to “untangle luck versus skill.” Over time, the skillful will outperform the lucky, even if it seems the lucky might sometimes have an initial competitive advantage.
As Jake also explains, good investor hygiene also involves going back to check your work. “Suppose you predict that Apple’s earnings will increase 10 percent by Q4 2022. When you get to that time period and the data becomes available, did that actually happen or not? What conclusions can you draw from how your initial prediction played out?”
These sorts of hygienic and value-seeking investment strategies don’t just apply to individual investors trying to build their personal wealth. As Jake explains, “I think the institutional money is not much different. Like us, they’re looking for the hot hand.”
But just as seeking value is important, it might be even more “hygienic” to try to avoid risks. As Jake explains, it is crucial to “avoid the problems and don’t go searching for heroic solutions.” Once again, it appears that balance remains the foundation to our overall well-being.
From there, Jake discusses the use of using better incentives to ensure he is building stronger relationships and creating win-win situations. As he explains, “You are a node in a web that is really sort of designing itself—it is hoping to create a structure in a way that can provide win-win relationships with all of the stakeholders that interact within that web.”
Personal relationships can go much further than having even the most in-depth dataset imaginable. “You can read every single publicly available document about a company,” Jake says, “And you will learn a lot about the company. But you can never really know what’s happening inside without additional information. The balance sheet can only go so far.”
To conclude, Jake knows that taking the additional steps to needed to prevent risk is key to maintaining good investor hygiene. “What I’ve learned the last few years is the importance of focusing on the left tail of possible outcomes. I need to think about and control for the possibility of the investment blowing up in my face or dropping to zero. I avoid situations with a very scary left tail, which is even more important than chasing investments with a very strong right tail.”
If we can approach the market with a financially healthy mindset, we can continue to improve our outcomes. This might not guarantee that anyone actually becomes the next Warren Buffett, but the hygienic mindset is certainly something that will put them in a much better position.