The Psychology of Money E-Book

Jim Ware

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 347

Veröffentlichungsjahr: 2012

Beschreibung

Discover the Ideal Investment Strategy for Yourself and YourClients "To enhance investment results and boost creativity, Jim Warereplaces the maxim know your investments with know yourself. And hegives us specific testing tools to do the job." --Dean LeBaron, Founder, Batterymarch FinancialManagement, Chairman, Virtualquest.company, and investment authorand commentator "Many investment firms fail, even though they are run byintelligent, qualified professionals, because they lack creativity.This book can rescue you. Jim Ware explains how to organize yourbusiness to encourage creative thinking. In five years, yourcustomers will be working with an advisor who read this book, somake sure you are the one who did." Ralph Wanger, President, Acorn Investment Trust, CFA andauthor of A Zebra in Lion Country: Ralph Wanger's Guide toInvestment Survival "Jim Ware has a great knack for understanding people andsuccessful investing. This unusual combination of skills creates arare find: useful insights to improve investment performancethrough helping people work together better. Jim's wit andhumor make this a fun read as well!" --Dee Even, Senior Investment Officer, AllstateInsurance Company, Property & Casualty "The Psychology of Money represents a major step towarddevelopment of a portfolio theory that recognizes human dynamicsand differences among people. Jim's content is solid, and hispresentation is engaging. This book ought to be on everypractitioner's bookshelf." --Kenneth O. Doyle, University of Minnesota, Author,The Social Meanings of Money and Property: In Search of aTalisman "Finally, an insightful look at the human side of investing. Astep-by-step guide to enhancing management performance to increasereturns." --Abbie Smith, PhD, Professor of Accounting.Universityof Chicago Business School

Leseprobe

Contents

Cover

Half Title page

Title page

Dedication

Copyright page

Preface

Acknowledgments

Part One: The Investor: Psychological Traits of the Masters

Chapter 1: Investment Masters: The Quintet

Chapter 2: The Eight Great Traits

1. Breadth: Taking in Information

2. Observation: Retaining Details

3. Objectivity: Thinking Clearly

4. Discipline: Being Consistent and Organized

5. Depth: Thinking in Focus and Independently

6. Creativity: Seeing the Big Picture and Using Metaphors

7. Passion: Maintaining Deep Devotion to the Subject

8. Flexibility: Being Open to Change, Going with the Flow

Chapter 3: Secrets of the Masters Complexity

Chapter 4: Self-Diagnosis

Extravert (Breadth)/Introvert (Depth): The Energy Source

Sensing (Observation)/Intuiting (Creativity): What People Pay Attention to

Thinking (Objectivity)/Feeling (Passion): How People Make Decisions

Judging (Discipline)/Perceiving (Flexibility): How People Choose to Live

Self-Testing

Chapter 5: Strengthening One’s Abilities: Drop and Give Me 50

Extraverts and Introverts: Stretching Exercises

Sensing and Intuition: Stretching Exercises

Thinking and Feeling: Stretching Exercises

Judging and Perceiving: Stretching Exercises

Striking A Balance

Chapter 6: The Ideal Investment Personality

Chapter 7: The Typical Investment Personality

Part Two: The Investment Team: Collaborative Techniques

Chapter 8: Teamwork Today?

Chapter 9: Golden Gloves or Golden Rule?

Chapter 10: Tools for Investment Teams

Identifying Preferences

Getting A Team Working Together

Chapter 11: Case History: Collaboration for a Money Management Team

Chapter 12: Temperaments and Teams: Implications for the Markets

The Guardian (SJ): Lions Rule the Kingdom

The Rationalist (NT): The Wise Old Owl

The Adventurist (SP): The Wily Fox

The Idealist (NF): The Compassionate Dolphin

Chapter 13: Temperament and Client Service

Part Three: The Creative Investment Team: Tools for Enhancing Creativity

Chapter 14: Brainstorming for the Masses

Chapter 15: The Creative Investor: Taming the Critics

Chapter 16: Creating a Safe Place

Exercises: Creating A Safe Place

Chapter 17: Guidelines for Safety

Exercise

Tools for Enhancing Creativity: “Acrobat”

Chapter 18: “A” Is for Assume Nothing

Exercise 1: Overconfidence Quiz

Exercise 2: Clean Slate

Chapter 19: “C” Is for Change Gears

Chapter 20: “R” Is for Risking Discomfort

Exercise

Chapter 21: “O” Is for Omit Either/Or Thinking

Exercise

Chapter 22: “B” Is for Borrow from Other Disciplines

Exercise

Chapter 23: “A” Is for Ask for Help

Exercise

Chapter 24: “T” Is for Tools and Techniques

Chapter 25: Getting Personal

Exercise: What Kind of Investor are You?

Part Four: The Intuitive Investor: Whole-Brained Investing

Chapter 26: Quantum Investing

Chapter 27: Waves and/or Particles

Chapter 28: The Case for Intuition

Chapter 29: Operating on All Cylinders

Index

The Psychology of money

WILEY FINANCE

Advanced Fixed-Income Valuation Tools, Narasimhan Jegadeesh and Bruce Tuckman

Beyond Value at Risk, Kevin Dowd

Buying and Selling Volatility, Kevin B. Connolly

Chaos and Order in the Capital Markets: New View of Cycles, Prices, and Market Volatility, Second Edition, Edgar E. Peters

Corporate Financial Distress and Bankruptcy, Second Edition, Edward I. Altman

Credit Derivatives: A Guide to Instruments and Applications, Janet Tavakoli

Credit Risk Measurement: New Approaches to Value at Risk and Other Paradigms, Anthony Saunders

Currency Derivatives: Pricing Theory, Exotic Options, and Hedging Applications, David F. DeRosa

Damodaran on Valuation: Analysis for Investment and Corporate Finance, Aswath Damodaran

Derivatives Demystified: Using Structured Financial Products, John C. Braddock

Derivatives for Decision-Makers: Strategic Management Issues, George Crawford and Bidyut Sen

Derivatives Handbook: Risk Management and Control, Robert J. Schwartz and Clifford W. Smith, Jr.

Derivatives: The Theory and Practice of Financial Engineering, Paul Wilmott

Dictionary of Financial Engineering, John F. Marshall

Dynamic Hedging: Managing Vanilla and Exotic Options, Nassim Taleb

The Equity-Risk Premium: Long-Run Future of the Stock Market, Bradford Cornell

Financial Statement Analysis: A Practitioner’s Guide, Second Edition, Martin S. Fridson

Fixed Income Securities: Tools for Today’s Markets, Bruce Tuckman

Fixed-Income Analysis for the Global Financial Market, Giorgio Questa

The Foreign Exchange and Money Markets, Second Edition, Julian Walmsley

Global Trade Financing, Harry M. Venedikian and Gerald A. Warfield

The Handbook of Equity Derivatives, Revised Edition, Jack Francis, William Toy and J. Gregg Whittaker

The Independent Fiduciary: Investing for Pension Funds and Endowment Funds, Russell L. Olson

Interest-Rate Option Models, Ricardo Rebonato

International M&A, Joint Ventures and Beyond: Doing the Deal, David J. BenDaniel and Arthur Rosenbloom

Investing in Africa: An Insider’s Guide to the Ultimate Emerging Market, Justin Beckett and Micael Sudarkasa

Investment Management, Peter L. Bernstein and Aswath Damodaran

Investment Timing and the Business Cycle, Jon G. Taylor

Investment Valuation, Aswath Damodaran

M&A: A Practical Guide to Doing the Deal, Jeffrey C. Hooke

Managing Credit Risk: The Next Great Financial Challenge, John Caouette, Edward Altman, and Paul Narayanan

Managing Derivative Risks: The Use and Abuse of Leverage, Lilian Chew

Measuring Market Risk with Value at Risk, Pietro Penza and Vipul K. Bansal

New Dimensions in Investor Relations, Bruce Marcus and Sherwood Wallace

New Financial Instruments: Investor’s Guide, Julian Walmsley

Option Pricing Models, Les Clewlow and Chris Strickland

Options on Foreign Exchange, Second Edition, David F. DeRosa

Options, Futures and Exotic Derivatives: Theory, Application & Practice, Eric Briys

Pension Fund Excellence: Creating Value for Stockholders, Keith P. Ambachtsheer and D. Don Ezra

Portfolio Indexing: Theory and Practice, Harold Hutchinson

Pricing Financial Instruments: The Finite Difference Method, Domingo Tavella and Curt Randall

Project Financing: Asset-Based Financial Engineering, John D. Finnerty

The Psychology of Money, Jim Ware

Relative Dividend Yield: Common Stock Investing for Income and Appreciation, Second Edition, Anthony E. Spare

Risk Arbitrage: An Investor’s Guide, Keith M. Moore

Risk Management: Approaches for Fixed Income Markets, Bennett W. Golub and Leo M. Tilman

Security Analysis on Wall Street: A Comprehensive Guide to Today’s Valuation Methods, Jeffrey C. Hooke

Style Investing: Unique Insight into Equity Management, Richard Bernstein

Using Economic Indicators to Improve Investment Analysis, Second Edition, Evelina Tainer

Valuation: Measuring and Managing the Value of Companies, Third Edition, McKinsey & Company, Inc., Tom Copeland, Tim Koller, and Jack Murrin

Value Investing: A Balanced Approach, Martin J. Whitman

For my wife, Janey, who masterminds all my work … I’m just the front guy.

Copyright © 2001 by Jim Ware. All rights reserved.

Published by John Wiley & Sons, Inc.

Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, 222 Rosewood Drive, Danvers, MA 01923, [phone], fax [phone]. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 605 Third Avenue, New York, NY 10158-0012, [phone], fax [phone], E-Mail: [e-mail].

MBTI, Myers-Briggs Type Indicator, and Myers-Briggs are registered trademarks of the MBTI Trust, Inc.

This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering professional services. If professional advice or other expert assistance is required, the services of a competent professional person should be sought.

Library of Congress Cataloging-in-Publication Data:

Ware, Jim, 1954–The psychology of money : an investment manager’s guide to beating the market / Jim Ware.p. cm.—(Wiley finance series)ISBN 978-0-471-3-9074-9 (cloth : alk. paper) ; ISBN 978-0-470-25041-9 (ebk); ISBN 978-0-471-43676-8 (ebk); ISBN 978-1-118-33702-8 (ebk)1. Investments—Psychological aspects. 2. Stocks—Psychological aspects. 3. Money—Psychological aspects. I. Title. II. Series.

HG4515.15.W37 2001332.6—dc2100-043608

Preface

I think self-awareness is probably the most important thing towards being a champion.

—Billie Jean King

If you know yourself and your enemy, you will not fear battle. If you know yourself but not your enemy, you will lose a battle for every one that you win; and if you do not know yourself and do not know your enemy, you will never see victory.

—Sun Tzu, The Art of War

If you don’t know who you are, the stock market is an expensive place to find out.

—Adam Smith, The Money Game

All business books claim to address and resolve a problem, and this one is no different. The problem examined here is that very few investment managers are beating their appropriate benchmarks. Professional money managers are not exceeding the returns that clients could get by investing in index funds. Simply put, money managers aren’t adding value. And investors know it, which is why the index funds are growing.

So, what can money managers do to improve their competitive records? More of the same? If so, they would have fallen prey to the “streetlamp syndrome,” captured in the story about the fellow who preferred to look under the streetlamp for his keys—rather than in the alley where he lost them—because the light was better under the lamp. These change-resistant money managers would also be guilty of behaving insanely, defined as follows: “doing the same thing over and over and expecting to get different results.”

Instead, I suggest that money managers look in some new places. Specifically, they can look in the right sides of their own brains. The right side of the brain—which contains our skills in creativity, collaboration, and intuition—remains relatively untapped in the corridors of Wall Street. In fact, I was making just this point to Patrick O’Donnell, head of research at Putnam, when he remarked, “There is virtually no professional literature about managing creative investment professionals.”

Surprised, I looked into it, and he was correct. There are tons of books on investment techniques and strategies, all presenting and advocating a particular viewpoint, but there are no books on managing the bright and creative individuals who run money professionally.

Thus the idea for this book was born. It is intended to fill an empty spot on the investment shelf. Mind you, there are lots of books on management in general and creativity specifically, but none that addresses the unique world of money management. In this sense, this book is the synthesis of my study and experience in three areas:

1. Professional money management (20 years as a Chartered Financial Analyst, finance instructor, and portfolio manager)

2. Psychology (Myers-Briggs® Personality Type instructor)

3. Creativity (designed and delivered workshops on enhancing creativity; plus wrote, recorded, and released two music albums, a music video, and a novel)

The book is organized into four parts. The first part analyzes the investment traits of five past masters (Buffett, Lynch, Soros, Wanger, and Zweig). It discusses the eight great traits that each of these masters possesses and that account for their superior investment records. It then offers the reader some self-diagnostic tools to determine which of these personality traits could be identified and strengthened for the reader’s benefit. In the course of this discussion, the reader is introduced to the Myers-Briggs Type Indicator® (MBTI®) personality assessment tool, which I use as a framework for much of the discussion about investment types. The part concludes with comments on whether there is an “ideal” investment personality and which personality is most common in the investment profession.

Part Two combines the Myers-Briggs framework with my experience in the money management field to examine the role of collaboration in the investment business. Tools and techniques are suggested to improve the effectiveness of teamwork. A case history is presented, in which portfolio managers using MBTI results and consensus decision-making methods achieved superior results. The part concludes with applications of the MBTI assessment tool to the management of client relationships.

Part Three moves from collaboration to creative collaboration. It asks: “How can investment teams enhance their creative effectiveness?” A number of practical guidelines, using investment examples, are given. A premise of this book is that investors will have to be more creative than ever before to win in today’s markets. (That’s actually how this book came to be. An editor from John Wiley, Mina Samuels, heard me talk to professional investors on “The Role of Creativity in the Investment Profession” and decided it was a hot topic. We’ll let you be the judge.)

The last part, entitled “The Intuitive Investor: Whole-Brained Investing,” examines the evidence for using intuition as an equal partner with logic in the investment process. It concludes with a look at current practices of successful businesspeople who do rely on intuition to help them run their businesses.

Finally, this book is also meant to be fun. If you’ve been having way too much fun lately, and you need a big dose of seriousness, pick up one of the thick books on either side of this one, with lots of equations and a title like, “The Conservative Investor’s Guide to Trading Derivatives: The Theory and Practice of Boring Your Competitors into Submission.” That should balance you out a bit.

Enough said. Let the journey begin! May your enhanced creativity, collaboration, and intuition allow your portfolios to flourish.

JIM WARE

Glenview, IllinoisNovember 2000

Acknowledgments

Thanks: To Judy Brownrigg at AIMR who got the ball rolling. To Mina Samuels at Wiley, who picked it up and ran with it. To Pamela van Giessen, who gracefully accepted the hand-off from Mina. To Jill Kneerim at Palmer & Dodge who kept the ball moving.

Thanks also to Dean LeBaron for his encouragement. And to various friends and colleagues at Interaction Associates, who provided stories and support throughout the process.

J.W.

Part One

The Investor: Psychological Traits of the Masters

Chapter 1

Investment Masters: The Quintet

The best thing that I did was to choose the right heroes.

—Warren Buffett

We start the journey by studying the habits of some investment masters. Habits are critical to success. Many of us have at some point been on a physical fitness jag. We do exercises, follow a certain diet, and set goals (weight, cholesterol level, etc.). Depending on our motivation level, we may even get the desired results. What often happens, however, is that we eventually fail because we cannot break our old habits. We still eat the sweets, butter the bread, skip the workout. Habits are extremely powerful forces in our lives. One psychologist, Earnie Larsen, estimates that as much as 98 percent of our behavior is governed by habits (Larsen, Stage II Recovery, HarperCollins 1985). The point here is that unless we change our habits, our exercise program will have little effect. And if we expect to get different results from doing the same thing over and over, then we are fooling ourselves. Remember the definition of insanity: doing the same thing repeatedly and expecting different results. (For example, mixing SlimFast with Ben & Jerry’s ice cream for your diet breakfast.)

Money managers fall into this “habits” trap all the time. They experience disappointing results at year end and resolve on New Year’s Day that they will do better in the coming year. How? By doing the same things, but more so. They dig faster and deeper in the same dry hole. Why? Because we learn as kids: If at first you don’t succeed, try, try again. Also, mediocre performance tends to makes us a bit nervous (read: pink slip). So, we tighten up and push for results. Studies show us that this pressing limits our flexibility and makes us less likely to try new things. We revert to our most predictable behavior.

Humans love routine, especially when we are under stress. Like lizards that dart out from under a rock, catch a fly, and dart back to safety, we figure out a routine that works and follow it religiously. Edward DeBono, a leading expert on creative thinking, asserts that the biggest myth about creativity is that humans are naturally creative (DeBono, Serious Creativity, HarperCollins 1992). We aren’t. We are creatures of habit. So this is where the definition of insanity applies. Investors must be willing to examine their results and ask, “Is my approach working?” If not, something must change. A mental fitness program for investors would involve identifying and changing unproductive habits.

What would such a program look like? Success in investing depends on the quality of our thinking. That is the skill a superior investor brings to the table. Michael Jordan brought superior physical skills (great agility and great eyesight); Elle McPherson has great physical beauty; Warren Buffett has superior decision-making skills based on his quality of thinking. What components of Buffett’s thinking produce these superior decisions? He reads the same financial press and studies the same finance and investment concepts as most other investors, but somehow he takes those ingredients and bakes a better lasagna. How does he do that?

This book explores that question and offers a mental fitness program for improved results. For those of you who like step-by-step, one-size-fits-all formulas, I’m sorryno can do. As with physical fitness, each person’s program must be tailored to his or her own body and health. But I can explain the concepts so that you can start to tailor your own program.

Returning to the question, “How does he do that?” I chose not only Buffett but also four other investment masters to study. I looked for common threads in their thinking styles, so that use-ful generalizations could be made. The chosen five had to meet three criteria:

1. They had to have exemplary performance records over a long period of time.

2. There had to be enough information available about them so that I could understand and analyze their thinking styles.

3. Their investment approaches had to be sufficiently different from the other four.

The last factor was included because I didn’t want the discussion to end up focusing on the old investment chestnut of growth versus value. (It might devolve into a beer debate: less filling, tastes great, less filling, tastes great …)

What approach is superior in investing? Evidence indicates that many approaches can win in the market, assuming that the investor has superior decision-making abilities. Figure 1.1 shows the five money masters and their records and approach.

FIGURE 1.1 The masters, their records, and their approaches.

Each of these investors is widely accepted as a master. The question is, what do they do differently? What habits have they acquired that lead to a superior quality of thinking? Can their thinking be replicated?

The premise of this book is that these investors share eight habits in their thinking style, which, in turn, lead to superior results. Can we ordinary mortals do it? Well, there’s good and bad news there: Yes, we can understand and copy it, but not easily.

We live in a culture that promotes instant everything. Faster computers, faster Internet access, faster food service. As with physical fitness programs, this mental fitness program requires a genuine commitment to achieve any real gain. Those who have made that commitment, though, have seen the benefits.

Successful investing, then, is the result of superior thinking combined with a reasonable approach. Different approaches can win in the market. The question becomes this: What qualities or habits do the truly successful investors share? Underneath their educational training, advanced degrees, IQs, and so on, what underlying factors separate them from the rest of us?

Buffett himself says that the differentiating factor is not IQ. And most of us have heard the old joke about Einstein in heaven, where he is asked to share a room with three others:

Einstein to first roomie: “What’s your IQ?”

First roomie: “150.”

Einstein: “Great, we can talk about relativity theory and quantum mechanics.”

Einstein to second roomie: “What’s your IQ?”

Second roomie: “120.”

Einstein: “Good. We can talk about literature and the arts.”

Einstein to third roomie: “What’s your IQ?”

Third roomie: “75.”

Einstein: “Oh. Well, how did the market close today?”

IQ and creative genius are clearly different. Many brilliant in-vestors fail, whereas some with ordinary IQs succeed. Richard Feynman, an excellent model of creative thinking, remarked that it wasn’t such a big deal to win the Nobel prizelots of people had done that. What was a big deal, though, was his winning it with an IQ of only 128! Again, IQ and creative genius are unrelated.

Without further delay, let’s look at the eight habits that these master investors share.

Chapter 2

The Eight Great Traits

Habit is habit, and not to be flung out of the window by any man, but coaxed downstairs a step at a time.

—Mark Twain

Don’t you hate those books—with titles like “The Secret to Prosperity: Investing in Bull Markets”—that take a simple concept and stretch it over five lifetimes? I read one recently where the author’s point was that leadership involves managing opposing forceslike the interests of shareholders versus the interests of employees. Valid point, but it didn’t require 281 pages to pound it into my brain. So in this chapter, I present the guts of my findings … briefly. That way there will be room for some other neat material in the book and you’ll still be able to finish this by the time the plane lands. Here are the eight great traits of master investors.

1. BREADTH: TAKING IN INFORMATION

Breadth refers to a person’s ability to take in data. Like radar that constantly scans the horizon, these five investors are ravenous for information. Their interests include not only domestic common stocks, but foreign stocks and other asset classesand interests outside of investing as well. Soros, for example, was a philosophy major and is deeply involved in world politics. Lynch is involved in charitable causes.

Consider Peter Lynch’s schedule when he was actively managing the Magellan Fund. He visited with about 50 managements per month, which meant more than 500 per year, traveling more than 100,000 miles. When not traveling, he received upwards of 50 broker calls per day and timed each one with an egg timer. Each salesperson had 90 seconds to make the pitch. Why? Because Lynch was hungry for more information. He wanted to free up the line for the next blip on the radar screen.

2. OBSERVATION: RETAINING DETAILS

Sherlock Holmes once remarked to Watson, “You see, but you do not observe.” What the legendary detective meant, of course, was that Watson did not see the significance of the small clues, the ones that unlocked the mystery. Again, all five of the masters share this capacity for details. This trait is different from the first (breadth). Two analysts might go to the same conference, but one would come away with a wealth of important details, whereas the other might retain very little. Retention of details, then, is key to successful investing. Ralph Wanger remarks, in his book A Zebra in Lion Country (Simon & Schuster 1997), that most research is just plain hard detail work. Likewise, Buffett is famous for his encyclopedic knowledge of the facts. He is able to recite the financial condition of all the businesses in his home town of Omaha, as if their balance sheets were printed on the facades of their buildings.

3. OBJECTIVITY: THINKING CLEARLY

The behavioral finance people have explored this area rather thoroughly, discussing such phenomena as overreaction, overconfidence, anchoring, and the like. Their point is that the economic assumptionthat humans are rational decision makersis false. Rather, we make systematic errors in our thinking that lead to predictable and exploitable investment mistakes.

The most powerful example of this in my experience occurred in 1989. Iben Browning, a climatologist for PaineWebber, predicted that a major earthquake would strike northern California in the fall. Iben was a great presenter, a good storyteller with provocative subjects: earthquakes, tidal waves, and volcanoes. I cannot remember any of his predictions coming true, but he followed the adage: often in error, never in doubt. (My own guess about Iben’s position at PaineWebber is that the firm’s economists wanted him on board to make their economic forecasts appear more credible.) Rather surprisingly, Iben’s prediction about the quake in Northern California proved accurate. Immediately thereafter, Iben’s stock as a forecaster shot up. The Wall Street Journal carried a story about him and his accurate prediction. Soon he issued another warning: that the New Madrid fault, which runs through St. Louis and the Midwest, would shift later that year. (This event was not unprecedented; in the nineteenth century an earthquake occurred in that area and shook church bells as far away as Boston.)

Iben predicted a similarly shocking blast. Closer to home, the news of this prediction began to affect my colleagues in Chicago, all of whom were professional investors and most of whom had advanced degrees and designations like Chartered Financial Analyst (read: intelligent). One by one these intelligent professionals bought earthquake insurance. That’s how strong panic mania can be. Of course, having studied behavioral finance and learned about our tendency to succumb to irrational fears, I was able to resist much longer than most before calling my insurance agent, Arnie.

Me: “Arnie, can you give me a quote on earthquake insurance?”

Arnie: “On what?”

Me: (softly) “Earthquake insurance.”

Arnie: “I’ve never quoted that before. Just a second.”

Returning after a few moments:

Arnie: “How would you like to buy some deep mining insurance?

Me: “What is that?”

Arnie: “Well, if someone is mining near your house and they set off an explosive that damages it, then your house is covered.”

Me: “Why would I want that?”

Arnie: “Well, it’s cheaper than earthquake insurance, and since you won’t need either, I thought I’d save you some money.”

As you know, of course, the joke was on my colleagues and me. We got pulled into the panic mentality, believing that there might be an earthquake. There never was. But the point is about objectivity and how hard it is to maintain. Dostoevsky, the great Russian novelist, was of the opinion that you can say anything you want about human beings, but don’t say they are rational. Behavioral finance people agree.

Despite the difficulty of remaining objective, Soros is known to be cool as ice under pressure, even when the stakes are high. As Lynch is fond of saying, “The stock doesn’t know that you own it, so don’t take it personally.”

4. DISCIPLINE: BEING CONSISTENT AND ORGANIZED

This trait is so important that several firms use it in their advertising. One firm proclaims, “Solid Performance Built on Discipline, Consistency, and Teamwork.” Zweig, the technician, agrees. He instructs investors never to “fight the tape.” In his book, Marty Zweig’s Winning on Wall Street (Warner Books 1997), he gives examples of the times when Jesse Livermore (his idol) went against this wisdom and regretted it.

Similarly, Buffett believes that the secret to investing isto use a baseball metaphorswinging at the perfect pitch. Wait for the fat one; don’t flail away at all the wild, crazy noise in the market. That is discipline. Hence his suggestion that each new investor be given a card with 20 punches on it. He believes that each investor will probably only have 20 or so great ideas in a lifetime of investing. So, wait for them.

Lynch admits that in his career he has fallen off his path several times. He says that he’s fallen for about 30 whisper stock recommendations. (These are the mysterious phone calls where someone whispers the name of a hot stock. Lynch comments: “Don’t they realize that the SEC can amplify these conversations?”) In any event, all of these stocks went bad for Lynch, reminding him yet again that he needed to stick with his strategy of extensively researching the management and business and learning the “story” behind the stock.

5. DEPTH: THINKING IN FOCUS AND INDEPENDENTLY

The French mathematician Pascal once remarked that most of the world’s troubles are caused by the inability of men to sit quietly in a room. This dictum can be applied to many investment analysts. How many of us can shut the door and think deeply and independently, rather than falling under the influence of what others say? The trait of depth acknowledges the importance of such thinking. Soros is known to permit no distractions when he is working. He is said to have unremitting concentration. It is this sort of focus that allows him to develop and implement winning trading strategies.

Similarly, Richard Feynman, the Nobel prizewinner mentioned earlier, made the same request when he started teaching physics after his work in Los Alamos on the atom bomb. He asked for several hours of uninterrupted time each morning so that he could think deeply and do the kind of thought experiments that Einstein had already made famous.

6. CREATIVITY: SEEING THE BIG PICTURE AND USING METAPHORS

A recent issue of Forbes magazine contained 12 ads for financial firms, all stressing their creative edge. Success in today’s rapidly changing world requires innovation at all levels: portfolio selection, asset allocation, marketing, recruiting, and so on. Ralph Wanger, one of our masters, is a fan of the metaphor as a creative tool. He encourages analysts to use metaphors to play with their ideas and avoid “hardening of the categories.” Furthermore, Wanger believes that intuition is a valuable ally, especially when it is developed through experience on the job. (More on intuition later.)

Also important is humor. Humor is a sign of a creative mind. These masters all have their own brand of wit, revealing their creativity. Lynch playfully speaks of finding great investment ideas in the malls, where his wifewho has a black belt in shoppingaccompanies him. He quips that if you spend 13 minutes a year studying economics, you’ve wasted 10 minutes. And he tries to find companies that any fool could run, because eventually one will. A playful mind won’t get hardening of the categories.

Similarly, Buffett is renowned for his dry sense of humor. He says that one strategy for increasing sales at Sees Candy stores was to spread the rumor that the candy is an aphrodisiac. It worked wonderfully. (The rumor, that is, not the candy.) He also writes that he and his partner, Charlie Munger, can compose a four-page memo with three grunts on the telephone. He bounces his ideas off Munger, who always tells Buffett that they are dumb. When Munger says they are really dumb, then Buffett reconsiders; but when they are evaluated as merely “dumb,” then he takes that as a vote of confidence and goes forward. He says of his relationship with Munger that they will be working together for many years to come, until eventually one day they look over at one another in the office and think, “Who is that guy sitting over there?”

The humor in these remarks reveals a playfulness that allows these masters to take their ideas lightly, to change their thinking when appropriate. They can step back and see the bigger picture.

7. PASSION: MAINTAINING DEEP DEVOTION TO THE SUBJECT

Master investors love the subject. They enjoy the journey more than the destination. Buffett jokes about enjoying the process more than the proceeds, though he says he has learned to live with the proceeds as well. He adds that he tap-dances into work each day. Zweig reveals that in college, when he began studying the markets, he fell in love with the numbers. Appropriately, he ended up as a technician, deeply involved with and working with the numbers. The market gods seem to favor investors whose motivation is from the heart, not greed. (Gordon Gekko aside, many master investors become active philanthropists.) Importantly, in the late 1980s, when Lynch stopped loving the market, he made the wise decision to get out. He knew the importance of passion and withdrew from active management when his own waned.

8. FLEXIBILITY: BEING OPEN TO CHANGE, GOING WITH THE FLOW

One portfolio manager friend was recently told by an exasperated colleague, “Do you know that you always answer a question with a question?” My curious friend responded, “Really? Is that bad?” (Okay, it was me.) Along with their capacity for creativity, these master investors also have the ability to remain open to new data and new paradigms. They are slow to shut the door on new possibilities, knowing that they might miss something important if they rigidly pursue a fixed strategy. Soros, a trader, is renowned for his ability to change on a dime. (Sometimes several billion dimes, in a single day.) He calls his system a flexible theoretical framework that can accommodate any global economic development. Likewise, Zweig says that the single reason why most investors fail to win in the markets is because they are not flexible.

Those are the eight traits that emerged as I read and studied the styles and strategies of these five masters. I’ve listed them in Figure 2.1 and have positioned them in a particular fashion. Does anything jump out as you look at these traits? Do you see a pattern? (Can you remember which of the eight traits helps you to spot patterns?)

FIGURE 2.1 The eight traits of the masters.

Some of you probably noticed that these traits are positioned as opposites, as polar extremes. It brings to mind the definition of mixed emotions: like watching your mother-in-law go over a cliff in your new Cadillac. The ability to move between extremes is what distinguishes the investment mastersand what makes creative genius a tricky proposition. For this reason, the next chapter is entitled …

Chapter 3

Secrets of the Masters Complexity

I get the facts, I study them patiently, I apply imagination.

—Bernard Baruch

Like Michael Jordan, who shoots and dribbles with either hand, these investment masters can go both ways. Similarly, Leonardo da Vinci is rumored to have been able to write with both hands simultaneously. Most of us, alas, can only do one at a time. The significance of this fact, as it relates to the eight traits, should not be underestimated. It helps explain why there are so few masters. They are masters precisely because they have the capacity to excel at both extremes. In a study on creative genius done by Professor M. Csikszentmihalyi at the University of Chicago, he found that this capacity to cover both extremes explains much of what we understand to be genius:

If I had to express in one word what makes [geniuses’] personalities different from others, it would be complexity. By this I mean that they show tendencies of thought and action that in most people are segregated. They contain contradictory extremesinstead of being an “individual,” each of them is a “multitude.” Like the color white that includes all the hues in the spectrum, they tend to bring together the entire range of human possibilities within themselves.

These qualities are present in all of us, but usually we are trained to develop only one pole of the dialectic. We might grow up cultivating the aggressive, competitive side of our nature, and disdain or repress the nurturing, cooperative side. A creative individual is more likely to be both aggressive and cooperative, either at the same time or at different times, depending on the situation [M. Csikszentmihalyi, Creativity, HarperCollins 1996].

When I talk about this subject to groups, they get a funny look at this point. It’s an expression that says, “Hmmm, there’s more to this than I originally thought.” The eight traits are not simply a laundry list of rituals to be completed, like flossing, brushing, and gargling. A dynamic tension exists within each of the four scales.

For example, the second scale, observation versus creativity, pits logical, linear, and detailed thinkers against creative, intuitive, and big-picture thinkers. Both forms of thinking are valuable, but it is difficult to be good at both, and quite impossible to be good at both simultaneously. (It’s a bit like the Magic Eye pictures that shift from two- to three-dimensional and back again as you stare at them.) Typically each of us has a preference for one type of thought or the other, much like left- and right-handedness; people are born with a preference for one hand or one type of thought over the other. In fact, to illustrate this point with a group, I ask them each to write their name on a sheet of paper. No big challenge, right? People do it effortlessly, without thinking. Then I ask them to write it again with the opposite hand. Usually there are a few audible groans and some laughter. It’s difficult, and for those of us who like to be masterly at all times, it’s kind of embarrassing. But eventually everyone does it. If necessary—say, if he or she broke the dominant hand—a person could become skillful with the opposite hand. Normally, though, we don’t even think about the choice of hands; we just sign checks with our “usual” hand.

There is a way that these two different ways of thinking —observation and creativity—show up in investing. When I ask investors, “What do you like in the market?” they typically reveal their preference in their answers. The detail-oriented, linear thinkers tend to give a response like this: “I like Merck right now. The company’s earnings per share have been growing at 13 percent over the past five years. Return on equity is 44 percent for the past year. The current P/E multiple is 28.7x, which compares favorably with the market average. They have three new products coming on the market that look promising, and their debt-to-equity ratio is under 10 percent. Earnings per share next year are expected to increase to $2.80 from $2.45.”

Contrast that response with this one from a creative, big-picture type: “I like the play on the graying of America. The baby boomers are aging and will require more prescription drugs. So, a natural play is the pharmaceutical companies.”

Notice the language in each response. The first is literal and factual: “13 percent,” “44 percent,” “28.7 multiple.” The second response is figurative and conceptual: “graying of America,” “baby boomers are aging.” In traditional investment dialect, the former is known as a “bottom-up” approach: Start specific and work to the general. The latter is known as a “top-down” approach: Start with the overview and work down to specifics.

To revisit our sports analogies, Michael Jordan had to develop complexity in his basketball game. He was born with a preference for one hand over the other (in his case, right-handedness). It would have been easier for him simply to become a right-handed dribbler and shooter, but he knew that he would never dominate the NBA with only “half” his weapons. Therefore, he worked tirelessly on developing his “weaker” side.

Likewise, master investors must become equally skilled from both sides of the brain. They must fire on all eight cylinders, which is another way of saying that they must master complexity. Many of us have well-developed preferences for one or the other poles, but not equal facility with both—and that is why we fail to achieve superior results. Sherlock Holmes said, “My peculiar art of detection results from the interplay of reality and imagination.” He meant that he had both observational and creative abilities. He could take in the facts and then play with them to see beyond them to the truth that we “Watsons” cannot perceive.

To give a sense of how complexity plays out with our master investors, Figure 3.1 shows some examples of them going to each polar extreme.

FIGURE 3.1 Complexity through opposition.

Without an understanding of complexity, the statements in the figure are confusing. The masters appear to be speaking out of both sides of their mouths. (Sort of like the man who said, “I used to be schizophrenic, but we’re better now.”) Their statements make sense only in the light of complexity. When viewed this way, they are showing that they can dribble with either hand, or—to use a tennis metaphor—that they can hit a backhand and a forehand equally well.

Some investors have asked me, “How well do these traits hold up in the decade of the 1990s?” After all, Peter Lynch hasn’t been actively managing money this past decade. Furthermore, a Forbes article, entitled “Quit While You’re Ahead” (February 7, 2000), states that Lynch’s approach—buy what you are familiar with—wouldn’t have worked in the 90s. The article uses Lynch’s picks from Worth magazine during the 90s and concludes that his selections would be valued as “27% less than identical sums put into the S&P 500.”

Ouch. Say it ain’t so!

Buffett is another case in point. He often mocks himself for not understanding technology and hence not investing in it. Modesty aside, his portfolio picks have suffered as a result of his techno-phobia. Blue-chip growers like Coke just can’t compete with the likes of Microsoft and AOL.

So, are these eight traits outdated? Or are there contemporary all-stars who demonstrate them?

I believe the traits are alive and well. In fact, I like them for this very reason. Regardless of cycles or fads, yuppies or Gen-Xers, the deep truths of life remain the same. As you will see in Chapter 4, the eight traits are based on deep truths about our psyches. But to make my point, consider a modern superstar, Mike Lu.

Mike Lu manages the Janus Global Technology Fund. This fund was up—brace yourself (especially if you didn’t own it)—212 percent in 1999. In that same period, average technology funds climbed 135 percent. The S&P 500 increased 21 percent. Lu is considered a superstar by his coworkers.