To become a doctor in the United States requires about twelve to fifteen years of higher education and hands-on training, depending on the type of doctor you ultimately want to become. Only after completing this rigorous curriculum and a grueling residency program, do you receive your license to “practice” medicine. But the one interesting observation I want to draw your attention towards here is this word: “practice”. You’d think, that after fifteen years of non-stop studying and training, you’d be a fully-qualified, bona fide master doctor. But in the field of medicine, there’s something supremely humbling about calling your profession a practice; because it automatically assumes the research and techniques of that subject are incomplete and still evolving, which they very much are. Doctors who practice medicine might very well be the best in the world in their particular area of expertise, yet they still operate (no-pun intended) under the this blanket idea of striving towards asymptotic perfection.
There’s probably a great deal more overlap between the worlds of medicine and money management than most investors think. On the surface, you have some obvious similarities: such as the relationship between the patient and physician (client and manager), the strategic alignment of both party’s interests, and the all-important risk mitigation. But there are also some more subtle overlaps, in the actual art of practicing medicine. Because, for a doctor, “success” isn’t just making sure your patient is free of illnesses, rather it’s actually to see your patient healthy and thriving again. And as a money manager, your goal isn’t simply to see that your clients are debt-free and sitting on cash, it’s to go above and beyond to provide financial robustness, assuring that their money is growing and well nurtured.
In an article entitled Paging The Portfolio Doctor, which originally appeared in Canada’s Financial Post, David Kaufman, CEO of Westcourt Capital makes this same observation and comparison. David writes about the first three core tenants of practicing medicine that apply directly to money management: “First, do no harm, Proceed only after receiving informed consent, and Prescribe no more than the minimum required dose.” The first of these rules is nearly identical to Warren Buffett’s own rule number one: Don’t lose money. So, if you imagine for a moment that a money manager is like a doctor, and a portfolio is like that doctor’s patient, it provides a new lens for examining investment opportunities. Instead of viewing investing as a something that is studied, mastered, and then complete, you can begin to think of it as a practice. A great doctor must study historic odd cases and also know the symptoms of thousands of illnesses to diagnose a patient appropriately. Yet, he or she must also treat every patient case as unique, and proceed with real-time caution, using only the information that’s available at hand. A doctor can’t just prescribe blanket solutions to every patient, because every patient’s needs are different: allergies, different responses to various therapies, and so on. But at the end of the day, every doctor’s goals are similar: patient health. How you actually get to that point however, looks different for every single person.
Daniel Gladiš, CFA is a seasoned investment manager at Vltava Fund. In an interview with Daniel, we discussed his particular views on the practice of portfolio management. Much like the way that solutions to medical issues vary from patient to patient, Daniel has reached similar conclusions in his ideas about investing:
Investing is not an actual science. There are no laws and there is nothing that is objectively true, so it’s a matter of opinion and judgment. I think it also depends on what your investment horizon is because the longer a horizon is, the more important the quality and the growth potential of the company is and the less important the price is. If your investment horizon is very short, then the long-term compounding means nothing.
When we asked Daniel to talk about what kinds of stocks he likes to hold in his portfolio and what he does with his time when he’s not actively making transactions, he mentioned that what he really strives for is simply to be prepared. In a way, this is also much like this idea of treating a portfolio like patient; because as every new patient comes in, all you can ever do beforehand is just be ready and armed with as much knowledge and technique to deal with whatever complicated situation comes your way. Here, Daniel notes that most of his work is in preparation:
We build a universe of stocks that we like or we love. We love to own at some prices and we try to have an idea what price is a good price and basically we cultivate that environment, that universe and that’s what we do. Very often, it doesn’t result in any transaction, but I don’t think the trades are something you should measure yourself with, whether you are working or not or building something. Most of the work, the value that you create is in the preparation, in the studying and reading. Then you just have to be patient and ready to act when the time comes. You have to know what to buy and you have to have the money and you have to have the courage when the opportunity comes.
But if all you have to do to achieve handsome returns in your portfolio is to be well-prepared, why then is it so difficult for money managers to consistently out-perform and beat their own benchmarks? In one of our posts on investment checklists, we discussed and shared many of the typical mistakes that investors make. And as experienced investors know, most mistakes aren’t quantitative miscalculations, but psychological failures. It’s in behaving irrationally that investors tend to get burned most frequently. But as Daniel says, rational thinking doesn’t always come naturally:
I think it’s the people’s nature. People always have a tendency to do things in a wrong way. They’re not patient, so they look for quick money, which is very difficult. It’s actually not difficult to make money in the long run in stocks. It’s extremely difficult to make money in the short run and the more you try, the more you lose, I think, on average. They’re not able to stick to the course, so whenever there’s a big correction, a lot of people just throws in the towel and runs away. They change course, they are overcome by emotions and they just never figure out and define themselves, what they actually want to do and achieve. I think it is this that makes it not easy, but investing itself is actually quite simple.
One final takeaway from our conversation with Daniel is on the logistical structure of the portfolio itself. In the same way that you might create different approaches or backup plans to tackle a problem, you can organize your portfolio and manage the money in tranches using various levels of risk and aggression. This compartmentalization of different “treatments” for different circumstances provides the investor the mental freedom and flexibility to allocate capital when it’s most advantageous, and be conservative when opportunities are scarce. Here’s Daniel, one last time on the three different levels of businesses he divides his own portfolio:
I see the portfolio as three levels. There’s Level 1 where there would be the highest quality businesses you can find and there are not very many of them. Maybe 20, 30, 40 of them in the world, not more than that. Of course, most of them are expensive, but if you are able to find some and you are able to buy them at good prices, you could hold them basically forever. You would only sell them in two cases. A) It would come so expensive that it really wouldn’t make any sense or B) if there’s a market crash because they would usually become a good source of cash because they would normally go down much less and would you give you cash for better opportunities.
Otherwise, you could own them forever and maybe a quarter of our portfolio sits there. Then there’s a second level of companies that are very good and you would still be happy to own them for a very long time, but they’re not the Coca-Colas or Berkshires of this world. They’re very small businesses, but just below the top level. This is maybe two-thirds of the portfolio. Then there are opportunistic situations where, like I said before, sometimes you have none and sometimes you have five. You can never plan for that, but I don’t think it makes sense not to do them just because they’re not top businesses. You can make very good money there.
Part of the beauty of building a diverse latticework of mental models is in seeing and applying the overlapping wisdom nuggets between disciplines. In this case, we’ve explored the practice of portfolio management from the perspective of a “practicing” doctor. Comparing portfolios to patients, and portfolio health to physical robustness, we can see that it takes a lot more than avoiding mistakes to be in top condition. You have to look for investment opportunities that offer positive benefits to your portfolio and avoid any risky situations that cause harm. Finally, you have to have the patience and humility to take each new opportunity case by case. Simply because it looks like something you’ve seen in the past, doesn’t mean it’s exactly the same. Every situation or patient is unique, and it’s to the advantage of the practicing money manager to not rush in. Instead, you can rationally look at the opportunity, and test out your ideas.
The best doctors in the world aren’t just the most technical. The best doctors have a combination of experience, patience, bedside manner, and passion for their practice. They see the human beyond the statistic, and they never lose focus on the ultimate goal of health.