One thing you need to be a great investor
Posted on November 2, 2007 by Richard Beddard
Filed Under Investing |
Apparently great investors have seven identifiable traits, but it’s a skill-set ordinary investors can’t learn. Don’t you believe it.
This speech is doing the rounds. Edmond sent it to me, and it’s sparked a bout of naval-gazing on the Motley Fool.
Mark Sellers, a hedge fund manager, ticks off the seven traits of great investors. Investors, that is, who compound their portfolios at over 20% “forever”.
Perhaps seven traits is too many. Points one to six seem to be nice-to-haves or corollaries or extensions of the magnificent point seven:
And finally the most important, and rarest, trait of all: The ability to live through volatility without changing your investment thought process. This is almost impossible for most people to do; when the chips are down they have a terrible time not selling their stocks at a loss. They have a really hard time getting themselves to average down or to put any money into stocks at all when the market is going down. People dont like short-term pain even if it would result in better long-term results. Very few investors can handle the volatility required for high portfolio returns. They equate short-term volatility with risk. This is irrational; risk means that if you are wrong about a bet you make, you lose money. A swing up or down over a relatively short time period is not a loss and therefore not risk, unless you are prone to panicking at the bottom and locking in the loss. But most people just cant see it that way; their brains wont let them. Their panic instinct steps in and shuts down the normal brain function.
Sadly, Mr Sellers spoils the moment. You can’t learn his seven traits. They’re deeply in-grained in the same way that supporting Arsenal, and therefore respecting greatness, is deeply in-grained in my kids. If you’ve not got it by the time you’re twelve, forget greatness:
I would argue that none of these traits can be learned once a person reaches adulthood. By that time, your potential to be an outstanding investor later in life has already been determined. It can be honed, but not developed from scratch because it mostly has to do with the way your brain is wired and experiences you have as a child. That doesn’t mean financial education and reading and investing experience aren’t important. Those are critical just to get into the game and keep playing. But those things can be copied by anyone. The seven traits above can’t be.
There’s that word ‘hard-wired‘ again. It’s repeated so often in the financial pages these days I’m convinced it can’t be true. It’s become the financial equivalent of an urban myth.
Mr Sellers says the seven traits are the great investor’s competitive advantage, or ‘moat’. I don’t know if he’s in that class of investor, but if he is, in seeking to persuade the rest of us we can’t learn to be great, he’s deepening his own moat and keeping the rest of us out of his castle.
Not everyone can be great, there’s always going to be somebody on top of the pile. But if learning one trait, and not seven, could make us much better at investing, it would be a good place to start.
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10 Responses to “One thing you need to be a great investor”
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Hi Richard,
It is interesting that Mark Sellers talks about the emotional side of your brain being a key factor (the ability to weight up managers and look at the big picture) but the book ‘Behavioural Investors’ talks about removing the emotional bias from your investment decisions. For me, I know I cannot utilise my emotions reliably to make investment decisions, so I would rather factor them out. As I am not trying to be a great investor I am not too worried about this. Above average will do just fine (but I could easily be suffering from over-confidence here also).
Another thing that Mark Sellers likes to do (if you read it on the Net), and Ken Fisher for that matter, is to build up a story which extols the virtue of buying a stock without actually analysing the downside much. This is another weakness you need to overcome (according to the above book).
However, Sellers does seem to be an unusual hedge fund manager in that he is selecting investments based on sounds principles (‘economic moats’ and ‘underlying asset valuations’) and less on clever mathematics.
As an aside, I read an (unusually) interesting article in ‘Money Observer’ magazine this month.
They were interviewing an investment trust manager who invests 20% of the funds money in hedge funds. It was a really interesting interview actually. Anyway, he said that most hedge funds are set up to go bust. I do not know if this is true but it has a nice ring to it. They will either make a killing or lose it all. In the latter case, I guess they move on and try to take a new bunch of rich people’s money to work with
Hi Robin, I think being ‘above average’ is underrated. There seems to be two kinds of investment commentary:
1. You can be the next Warren Buffett
2. You can’t so go buy an index tracker
I think we could go mad trying to match up the views of the various luminaries. The key point is the one you make, surely, which is to know yourself (and perhaps to keep learning, which is my point really). That way you can become the best investor you can be, which is the best any of us can realistically hope for!
Regarding hedge funds, there was a book “Hedgehogging” by Barton Biggs, that said pretty much the same thing, I think. There’s a mismatch somewhere between that and ‘absolute returns’, though!
Hi Richard,
I have always been dubious about absolute returns. I think this is just a marketing gimmick. Absolute returns cannot be achieved mathematically.
It has always amused me that the absolute returns fund managers explain their failures by saying that you need to invest in the stock market for several years in order to achieve absolute returns. If this is the case I can guarantee absolute returns also. Just invest in a global index tracker (and keep the profits at the end).
Note that I do respect the concept of reducing downside risk by shorting indexes. I am actually looking into this myself to see if I can work out an optimal ‘bleed’ rate based on past performance data. I have not managed to get my head around the various shorting options yet however as this is a fairly arcane investment area. It might take me a few weeks or more
Good luck on that one Robin. As always I’ll want to hear about how you get on!
Hi Richard,
I thought I would post an update on my investigations into shorting. It is quite intersting actually. This has led me to look at spread betting as the ideal UK vehicle to do any kind of short term (i.e. one day) trading.
I think that one day spread betting must be a behavioural investors dream! This is all about reading the prevailing mood and very little to do with underlying fundamentals. While I know very little about charting techniques, I would imagine the reason why charting can work in principle is because people keep making the same mistakes and there are a never ending stream of new investors out there to keep making them … forever.
Another interesting idea is to use spread betting to go long over the longer term. You need to overcome the daily financing hurdle. However, if you have a positive outlook on the year then I think there are many suitable investments. In this case, the key is to try to limit volatility as much as possible by diversifying across assets.
The final thing I would say is that shorting using US style ‘options’ is a very interesting idea and is also strongly tied to behavioural investing (i.e. if you feel the mood of the market has turned strongly negative, but has not yet been realised in the markets, then you could take out a put option on a volatile index). I suspect that the European style options, which can only be cashed in at the expiry date, are much less useful.
I would be interested to know your views on shorting and using leverage
Regards
Hi Robin,
Personally I don’t share your enthusiasm because I’m a long-term investor and the only time-frame I impose on my share selections is that I expect them to be in profit within three to five years or so and I’m quite comfortable with volatility in the meantime. Probably that’s out of necessity - in that the day job keeps me too busy to be trading stocks.
My view on leverage is that I’m mortgaged up to the eyeballs, but I choose not to pay off my mortgage because I think I can get a better return on my investments (mortgage is capped for life at 6.25%). So I’m already leveraged! Or at least, I’ve got enough debt, thank you, and although the costs of financing it are low it’s enough for me.
You can short in various ways, none of which I’m very familiar with (though obviously other writers comment on them from time to time on the ii site) - using CFDs, spreadbetting, options etc. As I understand it, there’s a cost associated with maintaining open positions and the risk you might need to stump up more cash to meet margin calls if the bet goes against you.
Both those factors necessitate a relatively short-term mindset that pretty much forces you into a momentum style of investing (i.e. to follow the herd as it stampedes up or down a trend). That’s all very well except I’m a contrarian bugger who tends to take the opposite view on pretty much everything, and especially stocks
So even if I had the time, which I don’t, I doubt shorting would come naturally to me.
That said I’ve just read an interesting article by Peter Temple on how you can use leverage to diversify that will go up on the main Interactive Site next week (here).
Shorting, leverage. They’re some of the tools of the trade. They’re not dangerous in the right hands but they’d be dangerous in the wrong hands - mine in this case! For all sorts of reasons.
Hi Richard,
I could not resist. I have opened a limited risk spread betting account and deposited enough money to make 8 tiny bets. The money (which I will probably lose) I regard as a small price to pay to see how the real markets actually behave and whether I can take advantage of these tools in the future.
I will let you know after I have made or lost my first million
Good luuuuuuuuck!
Robin, take a look at http://iball.iii.co.uk/2007/11/23/iball-interviews-david-buik/
Thanks for the link Richard. That was interesting. I have not listened to iball before now. There is nothing on the Cantor website which suggests that they operate in a fundamentally different way than any other spread betting company around (even though this is implied by the commentary early on).
My spread betting experience has been interesting so far. I have only taken one spread bet. The odds are so bad of winning! The thing I am interested in now are ‘options’ but these are not good value for money right now.
The following website is very interesting
http://www.learnmoney.co.uk/spread-betting/faq-4.html