5 Aces Investment Strategy

The investment world is full of gimmicks.  The "can't lose" this and "guaranteed to go up" that.  When I heard the "5 Aces" investment strategy, I chalked it up as another marketing ploy.

Until I found out what the 5 aces represented.

I attended the 2018 Daily Journal shareholder meeting to hear Charlie Munger speak.  It was there another board member, Peter Kaufman, outlined his approach to finding a world class investment manager.

The concept was simple: if you come across an investment manager with all 5 of these traits, you should hire him/her on the spot.

If you currently work with an investment manager that doesn't have these 5 traits, you should fire him/her on the spot (maybe a little harsh.)

The "5 Aces" was coined from the best poker hand you can get, wild cards included.  Here are what they represent in his terms.

Ace #1 Total Integrity

Translation: Your advisor will always do what is in your best interest.

Finding an investment manager that acts honorably is no easy feat.  The incentives to do something really stupid are magnified in the investment world.

Total integrity to most leads to a concept of trust.  When we ask clients why they use a certain investment manager, CPA, or attorney, usually the first answer is, "I trust them."

Problem is, trust doesn't lead to results.  Trust doesn't mean your advisor will always do what is in your best interest.

Integrity does.

So how do you know if your investment manager or advisor has integrity?  Read on.

Ace #2 Deep Fluency 

Translation: Your advisor has significant experience in what they say they do.

I love this one. The term fluency is rarely used in investing. 

Investing in intertwined with emotions.  Good advisors know how to keep your emotions in check and stay within your comfort zone of risk.

But when it comes to investing, you also need results.  And results are driven by talent.

Finding an investment manager or advisor with deep fluency is easy: ask to see the results.

As a caveat, deep fluency doesn't mean your results will always be better.  But it does mean that you are not afraid to show your results, explain how they are achieved, why your strategy works, and what conditions they work in.

In other words, someone with deep fluency has the proof to back up what they are saying. (Check out a company I use, Dimensional Funds, and their deep fluency.)

Ace #3 Fair Fee Structure

Translation: You should only pay for results.

When Peter first introduced the 5 Aces Investment Strategy, he joking (but somewhat seriously) said that it could lead to the firing of a lot of people.

This Ace is why.  Very few investment managers charge a fair fee.

If you have a deep fluency in investing, you stand by your results.  You know you possess the skills to stand out in the crowd.

As background, most investment managers and financial advisors work on a percentage fee structure.  Most common is charging a 1% fee to manage your investments.

When you get to the hedge fund world, a common approach is a 2% annual fee and 20% of the profits.

That means your advisor gets paid a percentage of your account balance AND a portion of the profits. They must possess some mad skills.

The question is then, what is a fair fee structure for investments? It is a hot topic, but one Warren Buffett tackled when he was managing money for other individuals.

Before Berkshire Hathaway, Warren ran an investment firm managing money.  His fee structure was based on his skill: He didn't charge any fees until you achieved a 6% rate of return and then took 25% of the profits above 6%.

Even more confidently, he added a high water mark.  Meaning every year, the 6% rate of return was on top of the highest value your account reached.

Warren believed in his ability (i.e. deep fluency) and was a man of his word (integrity) that if your account did not go up he did not get paid.

Talk about fair.

Ace #4 Uncrowded Investment Space

Translation: Go against the crowd.

To achieve above average results, you must separate yourself from the crowd.

Investing in the same area, or buying the same stocks, as everyone else will lead to the same results.

This is probably the hardest Ace to find.  The stock market today is so crowded, finding a niche or space that few people are paying attention to is really tough.

Add in the computers and algorithms that are now in the stock market and the future looks even bleaker.

But it does not mean it cannot be done.   

Small company stocks, value stocks, and alternative investments are a few well known areas that tend to be less crowded.

You can even look at areas outside the stock market. Venture Capital.  Currency.  Real Estate.  (But you've probably heard of all these already...see how hard it is to find an uncrowded space?)

Ace #5 A Long Runway

Translation: Age Matters.

When you hear how some of the most successful investors achieved their results, a common theme arises.

They stick to their game plan. 

You want someone who not only has the patience to stick with their game plan but also young enough to grow with you

Investing is a human business.  Try to find one you can grow old with.

Now you know what the best investors in the world look for.  Like winning the jackpot, finding a person that demonstrates all these qualities is extremely rare.  But if you even come close, you'll be in good hands.