“I always tell students in business school they’d be better off when they got out of business school to have a punch card with 20 punches on it. And every time they made an investment decision, they used up one of their punches, because they aren’t going to get 20 great ideas in their lifetime. They’re going to get five or three or seven, and you can get rich off five or three or seven. But what you can’t get rich doing is trying to get one every day.”
Warren Buffett
The Punch Card Approach: One of Buffett’s lesser well-known teachings includes the “punch card” approach to investing. The punch card approach, which Buffett first shared in the 1990’s to a group of college students, shares similarities with another less well-known investing approach called the "coffee can".
Buffett explains his punch card approach as follows: “I always tell students in business school they’d be better off when they got out of business school to have a punch card with 20 punches on it. And every time they made an investment decision, they used up one of their punches, because they aren’t going to get 20 great ideas in their lifetime. They’re going to get five or three or seven, and you can get rich off five or three or seven. But what you can’t get rich doing is trying to get one every day.”
With the increase in stock market volatility, it is tempting to react by increasing the rate of trading to avoid missing out on the opportunity to invest in great businesses at good prices. For professional investors, the increased trading activity also comes with the benefit of justifying client fees. However, it is well researched that increased trading activity does not correlate to outsized returns. What Buffett recognised is that, on aggregate, increased trading activity is inversely correlated with investment returns.
A punch card approach, assuming an investing career of 40 years, would imply making an investment on average every 2-3 years. While investments should be made as they arise, rather than on a fixed schedule, the Punch Card portfolio would not exceed ~20 holdings over the investor’s career. Within an institutional fund, this type of portfolio approach does not lend itself to justifying “active manager” fees. Most clients expect professional fund managers to pick stocks on a regular basis and outperform the market benchmark on a regular basis. Professional fund managers have a natural bias toward more activity, not less.
During periods of underperformance, the pressure to become ‘more active’ increases.
Individual investors do not have the pressures of justifying client fees that drive the bias towards activity. Individual investors can, therefore, take advantage of the punch card portfolio to outperform professional investors, utilising this ‘edge’ in favour of the individual.
The battle for the individual investor is therefore an emotional one, requiring the discipline to avoid over-trading due to FOMO, boredom, or greed. My personal distractions from over-trading include reading, writing this blog, speaking with business owners and entrepreneurs, spending time with family, friends, and my dog, and travelling. Each activity brings new learnings and reduces my investing activity which I can wholeheartedly say have improved my portfolio returns.
To read more on how long-term investing can help counter investor behavioural biases, I recommend this 2016 article by Capital Group on how ‘Long-term Investing can help counter investors’ behavioural biases” (link here):
The Coffee Can Approach: This approach is another less-well-known long-term investment strategy that can help individual investors outperform professional fund managers. The Coffee Can approach was developed by Robert Kirby in a 1984 academic paper (link here).
The paper describes an investor in the 1950s who piggybacked on the investment advice given by Kirby, a professional portfolio manager. This investor put $5,000 into each stock given a ‘buy’ recommendation by the fund manager, and importantly ignored any recommendations to sell stocks. With each stock bought, the stock certificate would be placed into a coffee can and never sold.
When the investor passed away, his wife retrieved all the stock certificates in the coffee can and discovered the results of each individual investment varied widely. Many investments were now significantly loss-making, however, quite a few were worth over $100,000, including one investment in Haloid (now called Xerox) which was worth $800,000 (on a $5,000 initial investment). The individual investor’s portfolio had significantly outperformed the fund manager’s portfolio over the same time period.
The coffee can approach requires thinking what companies will look like in 10-15 years. Are you making investments in durable businesses that will maintain their competitive moats over time? Is the business a disruptor or will it be disrupted by new technology? The requirement to invest with a long-term mindset is difficult. It is especially difficult for the professional investor as there is much career risk in underperforming in the short-term. As with the punch card approach, professional managers are highly incentivized to produce good short-term results, and so naturally, this is where they focus.
Conclusion: In the current environment, we have access to news headlines 24/7, and these headlines move short-term stock prices one way or another. However, as Buffett says what counts most after investing is just forgetting about your investment for a long time, and not get distracted by noise created by Mr. Market.
The Punch Card and Coffee Can investing approach focused on making long-term investments and reducing the bias for over-trading. The main tenet of both approaches is to let your winners run. Due to the short-term pressures on professional fund managers, it is the opposite of how most of the investment world operates.
“As your most successful investments grow in value, you make partial sales and transfer the capital involved to your less successful investments that have gotten cheaper. The process results in a stream of capital being transferred from the most dynamic companies, which usually appear somewhat overvalued, to the least dynamic companies, which usually appear somewhat undervalued”. Robert Kirby, 1984
Professional investors compete on getting better information and faster trade execution. However, these ‘edges’, are handicapped by the short-term pressure to generate returns and justify client fees through bias to action. Individual investors do not have such handicaps and can instead use the punch card and coffee can approach as their edge over professional managers as they focus on truly evaluating stocks as long-term ownership stakes in real businesses.