You will underperform. That’s right I said it!

We will all underperform at multiple points while investing in the stock market. I hate to break it to you, but it’s an inevitable fact of life that we will underperform the market from time to time — and it’s perfectly OK!

It’s a “Catch-22” in some sense — to outperform and compound capital at high rates over time, underperformance is a necessity.

If you want to beat the average index, you have to deviate from the index — it’s a simple concept, but far from easy to execute. It can be stressful and a hindrance when we deviate from the index during the short term. However, we gain a significant advantage long-term from this deviation. There are numerous investors who produced investment returns that are multiples over that of various indices. The only way they can accomplish this is by owning a portfolio that looks nothing like the index.

We believe in concentrating our best ideas into a focused portfolio. We want to own the cheapest, highest quality stocks with the best future. I have no idea whether these investments will rise today or tomorrow (BTW, no one does). However, I’m very confident that this strategy will work incredibly well over time.

The psychological pressure to succeed long-term in investing can be tough for most individuals.

Investors must stick to a long-term, rational system. We should consider ourselves lucky. By its very nature, the stock market shifts capital to the patient investor from those who are impatient and active.

WE WILL UNDERPERFORM. And you should welcome those periods from time to time. EVERY great investor will have periods of underperformance. Unfortunately, these periods can be longer than anticipated before the investor is proven correct for their patience. The problem is we only hear about the underperformance from the media because it causes more of an emotional feeling of loss for individuals. This tactic follows the closely held mantra in the media, ‘if it bleeds, it leads. ‘

These great investors have been vilified by many in the media for underperformance for a month or a quarter or even a year. They’ll say that they’ve lost touch with reality, or they’re missing the next great investment “revolution” or trend. I’ve heard this many times before from Warren Buffett “missing” the great and ever-growing tech rally in the late 1990s to Bruce Berkowitz after the financial crisis when he invested in AIG and many of the bailed out banks. In the case of Berkowitz, these investments went on to make him and his investors multiples on their investments.

All the greats have fallen from favor or replaced by those who are popular today, from Warren Buffett, Charlie Munger, Ruane Cunniff, Bill Miller, Bruce Berkowitz, Mohnish Pabrai, and Mason Hawkins —they’ve ALL underperformed for periods at a time.

We never focused on short-term performance (>3 years). Following a proven value investing process in a focused manner will likely lead to outperformance over time vs. indices or your competition. It’s brought us success, and it should bring success to many other as well.

If you haven’t embarked on this investing philosophy just yet…be careful. It’s vitally important that you understand and can combat certain psychological nuances that are likely to make you feel very uncomfortable at times. We discuss many of the mindsets and philosophies to focused investing in our book, Value Investing Edge (this is not a shameless plug, buy it if you want…if you don’t, it’s no skin off our backs. Regardless, we think it will be a welcome addition to any value investor’s library). Whether you purchase the book or not, understanding your philosophy, and the principles that come with that philosophy, can have a profound effect on your success long-term as an investor.

Investors should always ask themselves whether these principles make sense? Are they rational? Are they scalable and able to last the test of time? Has this process been successful in the past? Is the process likely to do well in the future?

In addition to improving my process over the years, I’ve spent a great deal of time focusing on putting myself in the right type of environment which will allow me to be uninfluenced and patient in my investing. I was fortunate enough to manage money in the US Virgin Islands for five years, and now I find myself in Charlotte, North Carolina.

Very different places to be sure. However, both offer the sanctuary I seek for the right type of environment to keep me focused on my long-term process. My checklists, my watch lists, and my environment have helped me tremendously over the years with investing in opportunistic, contrarian investment ideas that I can use in a focused manner for our portfolios.

Never has the road to wealth been one of “what’s popular today.” We stay away from these short-term trading vehicles with great stories and no earnings. We focus instead on high-quality businesses at reasonable prices (or special situations). This process takes patience and discipline, as well as being independent in your thinking.