Investing seems complicated to many people but the best strategies are often just the opposite. You can beat most investors if you learn to focus on the right things and simplify. That means finding effective principles you can easily implement and compounding those returns.
To get started on the right path, you can model a few ideas from a renowned physicist—Albert Einstein.
Step 1: Use Critical Thinking to Simplify
Einstein was intelligent, but he didn’t get the best grades or have the highest IQ. Rather, his style of thought was what separated him from his peers. Specifically, he had a unique ability to discern the big picture. Whereas many scientists drown themselves in data minutia, Einstein could see above the fray. That’s because he approached problem solving differently.
“If I had an hour to solve a problem and my life depended on it, I would use the first fifty-five minutes determining the proper question to ask, for once I know the proper question, I could solve the problem in less than five minutes.”
– Albert Einstein
If Einstein wanted to invest well, he’d spend time learning the physics of capital markets. He would likely start with a very simple question: What investing principles are effective?
That’s exactly what Warren Buffett did as a young man, when he attended Columbia University to master the methods of a renowned professor, practitioner, and pioneer in the field of investing—Benjamin Graham. When he returned to Omaha, Buffet began applying the value investing principles he learned, and after only a few years he was a multi-millionaire.
Success in most tasks generally results from two things: focus and effort. Before you bother to work hard at something, first make sure you’re working smart. Most people are biased toward activity. Yet the most important activity is deciding where to direct your attention. That’s what Einstein meant by taking 55 minutes to ask the right question.
Step 2: Practice “Combinatory Play” to Spur Creativity
After Einstein deduced what investing principles were effective, he’d solve the problem.
Throughout his life, Einstein practiced a mental game called “combinatory play.” Put simply—it’s the combination of existing concepts to form a novel idea.
For instance, Einstein did not invent energy, mass, or the speed of light. Yet he did reinvent our view of the cosmos with his e = mc² equation.
The beauty of the equation is that it explained so much with so little. It simplified the complex. That’s a wise mindset when developing a money management strategy. Investors are besieged by information and choices. Intelligent filters that produce smart shortcuts help a lot.
To develop such tools, Einstein would likely seek to connect existing finance principles in a novel way. He would employ creativity. One of the physical laws of markets is that to outperform, one must lead rather than follow. Creative thinking gets investors to the right places ahead of the pack. Connecting the dots quicker than the competition.
Perhaps Einstein would build his own multi-factor model, combining tried and true investing principles like quality, value, and tax efficiency, in a slightly novel way providing an analytical edge.
Investment knowledge is cumulative. Thus, a common career arc of many great investors is they start off by adopting proven methods of mentors, then they gradually add their own tinges of originality over time. Peter Lynch is a different type of investor than Warren Buffett and George Soros. But I strongly suspect if the three of them got in a room to discuss investing principles, there’s plenty they would agree on.
Figuring out what to do, for any task, is easier than it’s ever been. Nowadays, we have an information superhighway at our fingertips. We can “Ask Siri.”
However, knowing what to do is only half the battle. We still must do these things. Failure to follow through is where many come up short.
For instance, according to a Morningstar study, the best-performing mutual fund from 2000-2009 returned over 18% annually while the broad market was slightly down. Still, the average investor in this top fund managed to lose 11% annually on a dollar-weighted basis. How’s that? When the fund was on a roll, investors piled in. When the fund hit periods of turbulence, investors piled out.
Whatever strategy Einstein ran, it would be one he found easy to follow through with and stick to long term.
Of course, easy can mean different things to different people. A passive strategy may be easy for Vanguard founder, John Bogle, to follow. But the same strategy may be torturous for an impatient, alpha-oriented investor.
Your investment strategy should be custom tailored to suit your personality and position in life.
“The finding may seem unfair, but in both business and investments it is usually far more profitable to simply stick with the easy and obvious than it is to resolve the difficult.”
– Warren Buffett
Here’s an investing version of Einstein’s famous formula you can use as a guide:
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
– Albert Einstein
The people who compile the biggest fortunes play the compounding game best.
Most people view life through a short-term, linear lens. Consequently, people overestimatewhat can be achieved in a day or week, and dramatically underestimate what can be achieved over months or years of dedicated effort.
In the world of money management, two plus two can equal eight thanks to a subtle yet powerful factor known as exponential growth.
For anyone who may be unaware, here’s how compounding works. If you invest $100 today and get a 10 percent return during the next year, you start off next year with $110 to invest. So, there’s more money to make more additional money. That small edge, steadily magnified year after year, keeps growing bigger and bigger. And there’s no extra work to any of this.
For a well-constructed portfolio, time is a tailwind. If Einstein was running money, he’d focus on actions that compound the best long-term result, and so should you.
Markets are complex systems, but that doesn’t mean they require complex strategies to navigate them. Investing pros and “Average Joes” alike tend to overcomplicate and focus on the wrong things.
The keys to exponential success in any field, finance or physics, often relate to common thread principles. Among these are: simplification, innovation and continuously compounding effective actions in the pursuit of worthy goals.