Money makes money: 10 investing tips from Hamish Douglass

In the recent 100th episode of his podcast Inside The Rope, David Clark was joined by special guest and long-time supporter, Hamish Douglass of Magellan (Douglass first appeared in the second episode of ITR in 2017.)

In it, Douglass, who was then in London conducting business, was asked for his take on COVID, the reopening, Crypto, Robin Hood stocks, inflation, and the ongoing regulatory crackdown in China (all the more interesting given Magellan's well-known stake in Alibaba).

He also offered a short-term macroeconomic outlook.

However, the bulk of the podcast was given over to the investment lessons Douglass has gleaned from the great investors over the course of his singular career, among them Warren Buffett, Benjamin Graham, Phil Fisher, Peter Lynch, and Richard Thaler (under whom he studied at Harvard).

In this wire, I have cherry-picked 10 key investment tips that sprang from Clark's one simple but elegant question:

What behaviours through your career have you learnt or studied from others that have made you a better investor?

HAMISH DOUGLASS: It's a very good question, David. I spent a lot of time studying the great investors of the world, whether it's Phil Fisher, Ben Graham, Warren Buffett, or Peter Lynch asking how have they created these incredible track records.

And you pick up different things from different people, but also in your own experiences, you have to understand that you never stop learning in this game.

And if you think you know everything, that is the point where you really don't know anything. It’s about trying to understand some very complex issues. 

You try to predict the future in a future that has rhymes of the past, but always can be different in the future.

There are tools of the trade that I've picked up from people in my own lessons over time that, that I think are important for anyone in investing.

And I'm not sure these are in order of the most important things, but I think they're all important.

#1 The importance of a margin of safety

One, I would say I learned from Ben Graham and his great book Security Analysis was the proposition of a margin of safety. You want to buy assets at less than you think that they're worth in order to incorporate some room for error as things go wrong. And when things go wrong, you want to have a margin of safety.

If you're designing a bridge that can take a hundred thousand tonnes you don't want to set the safety limit at 99,999.

You'd probably want to set the limit materially below the maximum capacity of the bridge to make sure you're never testing that. And that's the same thing in investing.

You want to make sure that you incorporate some room for error in your analysis. And that, that was a very important lesson from Ben Graham.

#2 The circle of competence

I think this is really an important lesson from Warren Buffett and that's something he calls his circle of competence. You don't want to pretend to be an expert in everything because you become a know-nothing investor.

I describe our approach as an inch wide mile deep and very, very clearly defined areas in which we have expertise.

For example, we don't invest in biotech. There can be some great biotech investments, but I would say it's largely outside my area of competence or expertise. I'm not a trained scientist in that area. And we, we want to invest in areas where we really think we have some knowledge and some edge and things we can understand.

I also believe that it comes down to an issue of focus as well.

We're very, very clear at what we do at Magellan. We're very focused on very high-quality companies. High-quality companies aren't going to perform the best every single day of every single month of every single quarter. But, over time, they've got tremendous advantages because they have much lower failure rates.

#3 You have to be prepared to just throw something in the bin

Another thing I learned, and this comes to heuristic biases that a lot of people suffer, is you need to be prepared to walk away from investments.

That's really hard because often you spend an enormous amount of time and effort researching, or you can be in investments that go wrong, and then you start to convince yourself “oh, well, I can make my money back”.

You've got loss-aversion bias, you've got the cost of time, and you really have to be prepared to just throw something in the bin

#4 You have to be prepared to change your mind when the facts change.

You don't want to start refitting an investment case to a new set of facts and believing or convincing yourself nothing has changed.

So, when something's changed, don't be afraid to admit that you're wrong. And that's happened to us numerous times over my career that we've had to face reality and deal with it.

And I find it very therapeutic to actually admit not only to yourself, which is the first one, but to admit publicly that you've made an error.

The nature of the game is to not get focused on that one investment that can go wrong, but to focus on what I call the batting average of the portfolio.

It's easy to focus on, well - Alibaba had a bad year that year, but it's small in the context of the overall portfolio. What you don't want is a whole series of investments that go wrong.

And the batting average is all about having a very consistent win rate and minimising the error rate.

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# 5 A medium-term investment horizon

It's really important. It's really easy to say. It's really hard for people to do, to genuinely see out three to five years in the future and not to get caught up in the short term noise about how you're performing relative to the market - or what other people are saying. It's all about being able to see where the ball is headed and to back your judgement over time.

# 6 The power of compound interest

In our view, probably one of the most important lessons is the power of compound interest.

What you want to do is to be able to put your money into investments and effectively let those great investments work for you over time.

You don't care whether Microsoft is underperforming the index in the next six months. It is irrelevant. What is relevant is whether those investments can compound for you over five years, 10 years into the future.

What that rate of return is not about is one-off price changes, what you think the price can do in the next six months or 12 months. It's about whether investments can compound for you.

A quote I often give people is a quote from one of the founding fathers of the United States, Benjamin Franklin, and he said:

“Money makes money. And the money that money makes, makes more money.”

And if you think about it, that's what investing is all about.

It's about taking a longer-term view, backing the right businesses that effectively can compound their earnings at a very, very satisfactory, rate.

We've made many investments we’ve held for over 10 years. And many of these, if we take Microsoft, which is still our largest investment, we invested in 2014. So seven years ago, we took our major position, $28 a share. We have made 10 times our money.

This concept of time and compound interest is at the centre of what we do. You want your money to work for you. And we set ourselves an absolute hurdle over the long-term. After all fees, 9% per annum is our hurdle.  The strategy has done better than that over time.

You just keep learning more things all the time by reading and looking and hopefully being very honest yourself, what you get right, and what you get wrong.

# 7 Emotional detachment: What Richard Thaler taught me at Harvard

I actually went to a course at Harvard, that Richard was teaching so I had some firsthand experience with Richard. He's written some wonderful materials on heuristic biases, one of them is emotional attachment.

Some people have the right temperament for investing. And one of the things in the great investors like Buffett and others of the world, they're just very emotionally detached from their decision-making, it's just incredibly objective.

I'm lucky I'm fairly emotionally detached from things, and very driven by the analytics.

Buffet often says that the stocks don't know that you own them, and that's largely the case. And the way to think is that these stocks don't know whether you own them, or you don't own them, so don't get emotional about it.

I'm lucky I'm not that emotional. Maybe that's why I'm an oddball, slightly, here.

# 8 Don’t pick up coins in front of a steam roller: On Robin Hood stocks

Robin Hood-style investments are crowd-driven investments, and really for people who don't do their own work and analysis. To me, this is just crowd speculation rather than investing.

You know, some of these investments may be incredibly good investments and some may be absolutely terrible investments. And it's really a lottery, investing in that. I think investing is all about doing your own analysis, and it's not about what the crowd thinks.

So when, when the crowd is all moving in a direction, they all think they're heroes because everybody's just piling in, of course, as you put more people into a single investment, the price goes up.

That doesn't mean that the investment’s worth more money just because its price is going up. That's just more people are buying the investment.
But if that crowd changes direction, you could get murdered.

And to be in that investment, it's a bit like as Warren Buffett says: “These people go, oh, I know that, but don't worry, I know I'll get out of the investment.”

But the problem is it's like being Cinderella at the ball, you know, all these Robin Hood investors are in these investments, all thinking that they're smart, that they can exit the party at one minute to midnight. The problem is, the clocks have no hands at this party. And if you wait till it strikes midnight, everything turns to pumpkin and mice.

So, I regard it as fairly high risk. When things are all rosy, it looks like an easy way to make money, but you could be picking up coins in front of a steam roller,

# 9 Crypto is a mass delusion, headed to zero ...

The latest investor letter I wrote was on crypto and Bitcoin. I was just trying to point out that, that the lack of any substance behind something like Bitcoin, and it's really a study in human psychology. And I referred to it as a mass delusion. There is no intrinsic value underpinning, something like that.

The technology of the blockchain is incredible in terms of a distributed ledger, the proof, the concept is, is very smart.

Psychologically, it's playing on people's fear of central banks printing money. And the fact that there's a limited supply

 And I think it is inevitable that most of these digital forms of cryptocurrencies. that have no backing by government, or no tangible backing underneath them of any substance, will inevitably go to zero in the future. 

I can't tell you whether that's in 12 months or two.

#10 … But we are headed to digital currencies

The emergence of digital currencies in the world on the blockchain is real. 

We are going to move away from paper-based currencies of the world to digital currencies in the world. We are most likely going to have central bank digital currencies. Whether people have a direct account with the central bank on their ledger, or they're going to use the banking system to effectively stand between. It is a very important regulatory issue, but I think we will take paper, money out of society and we'll digitalize it on the blockchain.

So, what about you? Who are the most influential investors you have read or followed? What's the one tip you'd share with other readers?

Hamish Douglass referenced some great names and distilled some very simple but canny tips. We'd love to hear from you, too. What is the best investment lesson, or tip, you have learned? Is there one book, or even one quote, that you have found the most persuasive or influential? If so, please do share in the comments below. Thank you.

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The edited transcript above was drawn exclusively from Inside the Rope with David Clark. Listen to the full episode below: 

Hamish Douglass is Co-Founder, Chairman and Chief Investment Officer of Magellan Financial Group, and Lead Portfolio Manager of Magellan’s Global Equity strategies. Hamish is a former member of the Australian government’s Financial Literacy Board, the Australian government’s Takeovers Panel, the Australian government’s Foreign Investment Review Board and the Forum of Young Global Leaders – World Economic Forum. Hamish is a Director of the Victor Chang Cardiac Research Institute.