Ok, I'll admit it. I'm not exactly "normal". No, I don't have a strange growth on my neck or bark at people on the subway but I don't think I fit the mould that most 30-somethings have been forced into, either.
I have a degree in philosophy, not business, or engineering. I rail against getting hitched. Instead of going the corporate career route I decided to move to Asia and starting projects like Net Net Hunter. While all of these things seem unrelated to investing - I assure you - they reflect one critical characteristic needed to be a great investor.
When it comes to making any sort of decision, financial or otherwise, people tend to seek the guidance of others without even realizing it. This goes far beyond asking your friends and family for advice on buying a new car. Every single day we take in mountains of information just by observing other people. We learn about current fashion by observing what other people are wearing, or proper behaviour by how our colleagues are treating the division manager at our new job. All of this learning takes place without us even realizing it, never-mind having to put any effort into it.
While a lot of this learning is simple and harmless, sometimes it can really work against people. In uncertain situations, moments when someone is unsure what to do, people look to see what others are doing and then mirror that behaviour. Take a scenario where a man is laying on a busy sidewalk during the middle of the day. If everyone is walking passed, maybe stepping over him, other people will be far less likely to check to see if he is okay. Since the situation is somewhat uncertain (…it's an event outside of our normal day to day expectations, he could be drunk, sleeping, an actor, we don't know him, etc…) people look to others around them to see what they should do. The result is that nobody checks to see if the man needs help so he could be left in critical condition for hours. This exact scenario was tested by experimenters with a depressing results.
The pull to conform in terms of behaviour can be very powerful and it doesn't even take uncertainty. Psychologists conducted an experiment to see just how strong social influence was on decision making. They had test subjects line up in a room with 9 confederates, people who were knowingly playing a role to help the experimenters. The participants were shown two lines, one obviously longer than the other, and asked which of two lines was the longest. Each confederate answered in sequence before experimenters asked the test subject. Having heard each confederate answer that the shorter of the two lines was the longer line, the subjects overwhelmingly answered the same way despite how obviously wrong the answer was.
Great, but how does this affect my investment returns?
Investing is the perfect activity to set these types of psychological pitfalls in motion. There is a tremendous amount of uncertainty in the stock market and the economy, generally. Nobody really knows what will happen to a company over the next month, quarter, or year, never-mind which way the stock will go. On top of that, the movement of stock prices in the market provides a tremendous amount of social proof. Stock prices are essentially set just like prices are set at an auction - the stock is always sold to the highest bidder so when the price is rising the stronger the social proof is that investing in that particular stock is a good idea. The exact opposite happens when prices fall - a sinking price is strong evidence that people are staying clear of the stock and this provides powerful social proof that you should, as well. Add to that the effect that market commentators such as Jim Cramer or MSNBC pundits have and investors are assaulted by a constant drumbeat to conform.
As value investors we profit to the extent that we can maintain a rational analysis in the face of the herd behaviour of others. We buy when stock prices have been hammered and we sell when investors are starting to take an interest in our holdings. It is easy to play lip-service to value investing but being able to regularly take actions contrary to the crowd takes a strong emotional intelligence, an understanding of psychological pitfalls, and a global perspective crafted through experience as well as a tremendous amount of study. In the end you have to be able to ignore what other people think and forge your own path.
Emotional Intelligence and Net Net Stock Investing
Buffett says that what really counts in investing is having the right temperament. I'm convinced that a lot of this not only means having the ability to resist our natural human herd instinct but also means having strong emotional intelligence.
Back in the fury of panic during the winter of 2008-2009 my dad was busily pacing the halls of our family home. He was completely shaken by the direction his portfolio had taken. Over the preceding months he had watched it nearly cut in half and was intent on ending the pain by selling out of his positions. Of course, he knew all about value investing and what it meant to buy low and sell high using the value strategy but when put to the test he just couldn't stomach what was happening.
If you're of reasonable intelligence, it's fairly easy to find a good investment strategy and learn all there is to know about accounting. This will only take you so far, however. As an investor you also have to act on that knowledge when it suits you. Just like my dad showed during the turmoil of 2008-2009, even investors that openly acknowledge and believe in a deep value investing strategy can seriously buckle when put to the test.
As net net stock investors it's imperative that we're able to recognize the emotions that we feel when it comes to making financial decisions. It is critically important that we recognize how those emotions are shaping our analysis of the company and the situation so we can make better buy, sell, or hold decisions. When your net net stock drops by 50% after you bought it - as can happen fairly often - it is essential that you're able to assess the situation philosophically, with detached emotion, in order to judged whether you made an error or should load up on more stock.
Super Investors Have Super Temperaments
Investors such as Buffett, Graham, Lynch, or Greenblatt have an incredible analytical ability. The problem is, so do most other professional money managers… yet very few of them actually beat the market year in year out. What sets super investors apart isn't their ability to analyze a company, it's the strategy that they've chosen and their ability to implement that strategy by having the right temperament. Two critical factors that makeup that temperament is the ability to forge one's own path despite strong social proof and the ability to recognize and control the role of emotions in decision-making.
Luckily, as NCAV investors we don't have to be nearly as sharp as professional money managers have to be in order to realize market-thumping returns. Just putting money into a portfolio of qualifying net net stocks is enough to satisfy the analytical requirements of investing but we still have to have a strong control over our emotions if we're to excel as investors.