“To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks.” – Benjamin Graham
William Bernstein is one of the foremost advocates for individual investors. When he talks about the dynamics of investing, I pay attention to what he says and most of the time I agree with him.
In Bernstein’s underrated book, The Investor’s Manifesto, he shares his thoughts on the difficulty of investing on your own (emphasis mine):
Having emailed and spoken to thousands of investors over the years, I have come to the conclusion that only a tiny minority will ever succeed in managing their money even tolerably well.
Successful investors need four abilities. First they must possess an interest in the process. It is no different from carpentry, gardening, or parenting. If money management is not enjoyable, then a lousy job inevitably results, and, unfortunately, most people enjoy finance about as much as they do root canal work.
Second, investors need more than a bit of math horsepower, far beyond simple arithmetic and algebra, or even the ability to manipulate a spreadsheet. Mastering the basics of investment theory requires an understanding of the laws of probability and a working knowledge of statistics. Sadly, as one financial columnist explained to me more than a decade ago, fractions are a stretch for 90% of the population.
Third, investors need a firm grasp of financial history, from the South Sea Bubble to the Great Depression. Alas, this is something that even professionals have real trouble with.
Even if investors possess all three of these abilities, it will all be for naught if they do not have a fourth one: the emotional discipline to execute their planned strategy faithfully, come hell, high water, or the apparent end of capitalism as we know it. “Stay the course”: it sounds so easy when uttered at high tide. Unfortunately, when the water recedes, it is not.
I expect no more than 10% of the population passes muster on each of the above counts. This suggests that as few as one person in ten thousand (10% to the 4th power) has the full skill set.
So you’re telling me there’s a chance.
Bernstein is saying that roughly 0.01% of the investing public has the ability to put all of these factors together to be a successful investor.
For the most part, we’re in agreement on the factors that determine investment success.
Having an actual interest in the financial markets is an obvious prerequisite. The reason so many people don’t have their financial house in order is because they (a) become overwhelmed or (b) don’t care about finance because they find it boring.
One of the best ways to quell these feelings is to actually learn. It’s amazing how overlooked books can be as a source of wisdom from truly intelligent people. If you think about the brainpower that goes into writing a good book, it’s mind boggling. Not only do you get the collective thoughts of the author, that they have been developing for many years in most cases, but you get reams of research from other intelligent people as well.
Basic math skills are important to a successful investor, but I don’t think it has to be too complicated. Peter Lynch once said, “All the math you need in the stock market you get in the fourth grade.”
One of the biggest areas of weakness for many investors is a lack of understanding of compound interest with regards to exponential growth from saving early and the impact of costs.
A grasp of probabilities is also important to be able to weigh your options when making educated investment decisions about the future based on incomplete information.
The two most important abilities listed by Bernstein are the ones I spend most of my time studying and writing about — financial history and emotional discipline.
You can probably get by with subpar abilities in math or a love of the game, but it’s impossible to succeed without knowing how the markets work and having the emotional intelligence to put a solid process to use.
While I agree with the four abilities listed by Bernstein, I don’t necessarily draw the same conclusion.
I’m more inclined to agree with the Benjamin Graham quote at the top of this post. Achieving satisfactory returns is a worthy goal for 99% of all investors. Investors get themselves into trouble when they shoot for superior performance without understanding their own limitations.
The top 1% of investors are all masters of the four tenets listed here in addition to being supremely intelligent. If you study Buffett, Marks, Soros, Lynch, Dalio, etc. you will find that even though their strategies differ, they all share the ability to control their emotions and make clear, probability-weighted investment decisions based on past experiences.
Learning from the giants in the industry on these basic tenants can help individual investors see the big picture, but that’s probably as far as you should take it. It’s a mistake to assume you should be able to earn the same returns as these guys.
You don’t have to try to be the greatest investor of all-time because it’s an impossible dream that can only lead to mistakes. Investors should learn to be comfortable with satisfactory. Satisfactory can still help you achieve your goals.
Every single study on investor behavior shows the majority have a problem even reaching average performance because they make the wrong decisions at the wrong times. To be a really great investor is extremely difficult. To be a better than average investor is actually very simple if you are able to control your behavior (which is why Buffett says it’s simple, but not easy).
Based on Bernstein’s assessment of investors I would assume he would advocate finding a professional that can fill in some of the blanks for your deficiencies. Financial advisors that can offer advice, education and a sound investment process are worth it if they can help you reach your goals.
For those investors that would still like to make a go of it on their own, I suggest you reign in your expectations.
The Investor’s Manifesto
On the merits of being a financial historian