One of my favorite newsletters is The Hulbert Financial Digest. Their job is to track the performance of newsletters like ours. The following is an article from the October 21, 1996 issue that I found interesting. (Reprinted by permission, The Hulbert Financial Digest, 316 Commerce Street, Alexandria, VA 22314, 1-703-683-5905. Or contact their web site at... http://www.hulbertdigest.com.

Is your job complete once you’ve decided which newsletter to follow? Not at all, even though it’s tempting to think the hard part is now over. But believe it or not, one of the trickiest parts of using newsletters profitably begins at this precise point.

What you still must do is have the discipline actually to follow what the newsletter recommends that you do. Such discipline is crucial to making the most of whatever newsletter you’re following. Yet relatively few newsletter subscribers have such discipline. Over and over again I hear about subscribers who choose a perfectly decent newsletter to begin following, and then start second-guessing its advice. They thus lose the benefits of whatever discipline their chosen newsletter otherwise provides. More often than not, in my experience, these subscribers eventually regret their loss of discipline.

THE BENEFITS OF DISCIPLINE

To appreciate how important discipline can be, consider a few statistics concerning the performance of the typical investor in Fidelity Magellan. The fund itself has been one of the top long-term performing funds, with an annualized gain during the 1980s and early 1990s of between 20% and 25% annualized. This is how much an investor would have made simply by buying and holding Magellan. Believe it or not, however, according to Dr. John Schott, editor of The Schott Letter, the average investor in Magellan between 1980 and 1992 actually lost 12.0% over an average seven-month holding period.

How can investors in a hugely profitable fund nevertheless lose this much money? By not having any discipline. It turns out that many investors were lured back into Magellan after each rally in the stock market, only to be scared out of the fund after each correction. They thus were constantly being whipsawed at a loss.

What would have helped these investors over these dozen years is the discipline to stick with Magellan through thick and thin. However, this doesn’t mean that buying and holding is the only form discipline can take. It isn’t. For example, discipline could also be a trading strategy that provides clear timing signals for when to get into and out of the fund.

Discipline is what immunizes us from the strong emotions that get inducted within us by the market’s rallies and corrections. Our emotions are profoundly unhelpful as a guide to investing: When ruled by our emotions, we tend to get more bullish as the market goes up and more bearish as the market declines. And that’s the essence of buying high and selling low. When we have discipline, in contrast, we act when our investing philosophy says to act, regardless of whether or not it feels good.

This is why second-guessing your chosen newsletter is so fraught with peril. Unless you have a systematic approach to your second-guessing–which is quite unlikely–then doing so leaves you without any discipline whatsoever. And in that state of mind you are entirely too subject to being swept by the market’s emotions.

THE VALUE LINE EXAMPLE

Another reason to have discipline is that no investing system works equally well at all times. Indeed, there are occasions on which any system will not be ‘in synch’ with the market. The temptation is great on such occasions to junk one’s system. Yet it’s also very dangerous to succumb to this temptation.

The Value Line Investment Survey provides a good illustration of how portfolio discipline helps to deal with all the reasons and arguments for change. This newsletter is in first place among all the services the HFD has followed since 1980. Yet, on several occasions over the last decade, the Value Line stock ranking system temporarily stopped working. Stocks considered to be the worst bets were outperforming the stocks considered to be the best bets. Pressure was intense on Value Line to redesign its stock ranking system.

Fortunately for Value Line, it had a discipline in place for dealing with these pressures for change. That discipline enabled Value Line to respond to those arguments and not revise its ranking system. And so far, at least, Value Line has had the last laugh when deciding not to change.

What is the discipline? According to Value Line’s research chairman, Samuel Eisenstadt, a proposed redesign of its ranking system must show that the change would have improved its performance over the entire period since inception in 1965. Notice how powerful a discipline this is. Changes that would merely improve recent short-term performance aren’t good enough.

 

 

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