The Right Stuff
I find it fascinating to think about what it is about the great investors like Warren Buffett that makes them great. What sort of personal qualities and abilities do they have that allow them to succeed?
One can think of two types of investor qualities: 1) personality; and; 2) brains. They overlap but it is useful to keep in mind that we are looking at two kinds of things.
Warren Buffett recognized this distinction. Roger Lowenstein, in one of the best ever Buffett books wrote: “Buffett said it did not require a formal education, nor even a high IQ. What mattered was temperament.” (Lowenstein, Buffett, The Making of an American Capitalist 1995,2008) p.333.
By ‘temperament’ Buffett is referring to what I call ‘personality’.
The focus of this post will be on the brains rather than the personality. I will focus on the needed intelligence. My thesis is that the needed investor intelligence is different than raw brain power.
Raw brain power
Nobel Prize winners and other highly regarded academics in economics and finance frequently show no special aptitude for investing. The raw brain power is there.
The original poster child for this was Isaac Newton. After losing his shirt in the South Sea Bubble he reportedly said “I can calculate the movement of stars, but not the madness of men.” (Wikipedia). Lord Radnor is said to be the source of this quote. We learn from Newton’s niece that he lost some twenty thousand pounds, the equivalent today of millions of pounds. Newton was no fool when it came to money. For many years he ran the British mint.
A more recent example was the brainiacs (two Nobel prizewinners) at Long Term Capital Management, a highly leveraged hedge fund that went down in 1998 needing a $3.5 billion bailout. One of its founders wrote recently: “The lesson: good investments plus bad sizing can result in cataclysmic losses.” (Haghani and White, The Missing Billionaires 2023) p.5, as if that was the only lesson.
Reasonably good intelligence
So, what intelligence is needed? To begin with, you don’t have to be a mathematical wizard. Some people think that investing is all about understanding numbers. The mistake many make is to think investing is only about the numbers. We invest in businesses, not in financial statements. The businesses are run by people. They have products that compete in different markets. The competitive environment changes. Consumer tastes change. Technology changes. So, the numbers are only part of it. As well, investors have access to analysts’ reports. The analysts do most of the number crunching for you.
Warren Buffett says that his attitude when buying common stock is to “approach the transaction as if we were buying into a private business…..When investing, we view ourselves as business analysts – not as market analysts, not as macroeconomic analysts, and not even as security analysts.” (Buffett, The Essays of Warren Buffett: Lessons for Corporate America. 1998) p.63
A business analysis is as much, if not more, a qualitative analysis than a quantitative analysis. It must be done with common sense and business sense. We must always remain skeptical of the numbers. As Warren Buffett put it in his 1986 Chairman’s letter: “…accounting is but an aid to business thinking, never a substitute for it.”
Investing does require some ability to understand statistics, financial statements and financial ratios such as Return on Invested Capital. What is needed is the ability to understand, for example, what a particular financial ratio means. This is something we can learn. We learn not only what it means but also its limitations, how it can be misleading and how to view it with a skeptical eye.
Emotional intelligence and more
Some have tried to distinguish between ordinary intelligence and emotional intelligence. I think the notion of intelligence is much more complex when it comes to an activity such as investing. The investor needs the ability to understand human nature; the ability to manage intuitions and instincts and sometimes think counterintuitively; the ability to learn from experience; the ability to focus on the relevant and see the big picture; the ability to think strategically; the ability to avoid mindset and self-confirmation; and, the ability to exercise sound judgement.
The ability to cut the wheat from mental chaff
Sound judgement is a kind of intelligence. The ability to learn from experience is also a kind of intelligence. They come from the working of the mind – mental processes. And experience is more than memory. It is memory processed into usable learning, the ability to cut the wheat from mental chaff – clarity of thinking. It is a skill that requires more than raw processing power. One might ask if clarity of thinking is an innate faculty or whether it can be learned. Does it develop from experience? Is this what we call expertise? I believe it can be cultivated.
Intuition and intelligence
There seem to be both the intuition we are born with and what may be called learned intuition. The wise use of our intuitions is also our intelligence at work.
An investor must be able to think counterintuitively – i.e. must be able to override one’s intuitive feelings. In fact, it goes beyond that. One must be able to develop learned intuitions or learned instincts which are often counter to natural intuitions or instincts.
A classic example of this occurs when a stock, an industrial sector or the whole market is going down. One’s instinct is to cut and run. But that may be precisely the wrong thing to do. Another example is when a financial crisis hits. One’s instinct is to sell everything and hold cash until the storm blows over. That also may be exactly the wrong thing to do. In fact, I would hazard to say that the best investment decisions are frequently the ones that are counter-intuitive.
Insight as intelligence
Related to intuition is insight, also a kind of intelligence. The notion of insight takes us into the creative side of our minds. It seems to be the ability to see things that others may not be able to see. Investing does require insightful thinking. It also requires an ability to think outside the box.
The intelligence to keep it simple
All of the above may seem very complicated. In fact, the truly intelligent investor has a way of keeping it simple.
Lowenstein reports: “Most of what Buffett did, such as reading reports and trade journals, the small investor could also do. He felt very deeply that the common wisdom was dead wrong, the little guy could invest in the market, so long as he stuck to his Graham-and-Dodd knitting. But people, he found, either took to this approach immediately or they never did. Many had a “perverse” need to make it complicated.” (Lowenstein, 1995,2008) p.331’
Warren Buffett describes the Graham-and-Dodd knitting approach he has used over the last 50 years:
“Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio’s market value.” (Buffett, 1998) p.93 His style is thus to identify businesses he feels can achieve that end and buy them at ‘an attractive’ price. (Buffett, 1998) p.85 Note, he does not require that they march steadily upward. There is a normal lumpiness to the earnings of even the best companies. The only earnings that grow steadily are those that are ‘managed’ by the CEO and CFO. The ‘attractive price’ is to provide a margin of safety.
So, to succeed as an investor, the brainpower you need is reasonably good intelligence broadly defined. You don’t have to have a soaring I.Q. to do well. You don’t need a Ph.D. in math. The notion may be more about smarts than raw brain power. Overriding all is the importance of reigning in our natural overconfidence and remaining humble.
Readers wishing to dig further into the personal traits needed to be a successful investor might take a look at the following sections of the Motherlode:
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