In Search of Temperament Final – Measuring Success

This is the sixth and final instalment in our series on the ideal investor temperament. So far we’ve considered curiosity and flexibility, contrarianism, patience, self-awareness and self-control and probabilistic thinking. This post is all about how the best investors measure success and how they treat others.

What’s Your Scorecard?

You might think that successful investors measure their success by counting the money that they made. If so, you’d be mistaken. There’s no denying that making money is important but it can never be the sole or even the most important measure of success.

This is because there is simply no guaranteed way to make money. As Wes Gray of Alpha Architect pointed out in one of my favourite blog posts Even God Would Get Fired as an Active Investor. An omnipotent being with perfect foresight five years ahead would have generated almost 30 per cent per year picking stocks on the S&P 500. But even a deity experiences major drawdowns. On three occasions between 1927 and 2016, the almighty under-performed the S&P 500 by over 50 per cent on a rolling 12-month basis.

Another study by Vanguard took the 1,540 active mutual funds available in 1988 and considered their performance over the next 15 years. Only 55 per cent survived the entire period. The rest, almost 700, either merged or were shut down.

Of the 842 funds that survived, only 275 or 18 per cent managed to beat their benchmark over the period. Most importantly, 97 per cent of successful mutual funds experienced at least 5 years of underperformance!

Hopefully you now see why success can’t be just about the money. There’s too much luck involved; especially over the short term. Investors have very little control over outcomes, so focusing on them almost certainly leads to disappointment.

Remember, great investors think probabilistically. They understand that decisions carry a distribution of possible outcomes. They also understand that this distribution is wider than most people expect. In other words, the actual outcome is one of many possible outcomes, not all of which are favourable. Considering the full range of outcomes is what being a contrarian really means.

This is why other aspects of the ideal investor temperament such as patience, self-awareness and self-control are so important. These attributes help great investors to cope with uncertainty.

We can’t complete a series on the ideal investor without a gratuitous quote from Warrant Buffett:

“The big question about how people behave is whether they’ve got an Inner Scorecard or an Outer Scorecard. It helps if you can be satisfied with an Inner Scorecard. I always pose it this way. I say: ‘Look, would you rather be the world’s greatest lover, but have everyone think you’re the world’s worst lover? Or would you rather be the world’s worst lover but have everyone think you’re the world’s greatest lover?’”

Buffett has experienced several periods of looking like ‘the world’s worst lover’. The most notable period was in the late 1990s when the cover of Barron’s featured the headline ‘Warren, What’s Wrong?’.

Investment returns are an outer scorecard. They invite comparison; leading pride when you’re hot and envy when you’re not. All of which takes the investors focus off the one thing that they can control: their investment process.

What might an inner scorecard look like? Jim Paul taught us that each investor must establish their own set of rules. These rules are the answer to the question of ‘what constitutes an opportunity for you?’ Your inner scorecard could be a measure of how closely you’ve stuck to your rules.

An inner scorecard involves examining how you spend your time. For example, if you’re a long-term investor, how much time do you spend reviewing short-term performance? Does the investment research that you read align with your investment horizon?

Great investors are curious. It’s natural that their inner scorecard would also emphasise growth, on both a personal and a professional level. Buffett recommends that investors stick to their ‘circle of competence. But there’s no reason why investors can’t widen that circle over time. Buffett himself is a great example. Apple is now Berkshire Hathaway’s largest stock holding, despite Buffett previously stating that technology companies were outside his circle of competence.

Successful investors also work hard to manage their behaviour. Specifically, this means trying to avoid the trap of internalising profits and losses.

A Fisherman Always Sees Another Fisherman from Afar

In Wall Street: Money Never Sleeps Gordon Gekko (Michael Douglas) tells Jake Moore (Shia LaBeouf) that ‘a fisherman always sees another fisherman from afar’. We often recognise people with similar traits and interests to ourselves and the same is true of great investors.

A curious person values knowledge. So, it’s not surprising that they often become teachers when they encounter curious minds. Warren Buffett and Charlie Munger are excellent examples of this. Both men have shared their thoughts and experiences in letters and interviews. Despite advanced age, they answer questions from shareholders for hours at the Berkshire Hathaway and Daily Journal annual general meetings.

Great investors march to the beat of their own drum, are contrary in their thinking, patient and they learn to work with uncertainty. If they are also self-aware, they will understand that other investors also need the freedom to work this way. As bosses, they don’t micro-manage.

Once again, Buffett and Munger are classic examples. Berkshire Hathaway is incredibly decentralised for a firm of its size. Buffett retains responsibility for capital allocation decisions. But once he allocates capital, whether it’s to an operating business or the stock portfolios run by Todd Combs and Ted Weschler, they have the freedom to invest.

Great investors also recognise that other skilled investors are smart and hungry. Delegating the authority to make investment decisions is an important way to satisfy that need. After all, anyone who’s smart and curious will soon outgrow a job where all they do is implement someone else’s ideas.

Sometimes this means leaving the firm to start up on their own. A perfect example of this is Tiger Management run by Julian Robertson. Robertson admits to being disappointed and hurt when several members of his staff left to set up shop. But he soon got over this feeling.

Firstly, Robertson made a point of hiring competitive and ambitious people. So, it can’t have been a total surprise that this would be the result. Secondly, he realised that this was also an opportunity. Rather than feel betrayed, he invested in these ‘tiger cubs’.

In my chat with Rich Pzena, we discussed Rich’s time working at Sandford Bernstein and what he learned from working with Lew Sanders. Rich admitted that back then he couldn’t understand why Lew seemed to radiate ‘fatherly pride’ every time one of his team left to go onto bigger and better things.

Now a business owner himself, Rich understands. He also feels a sense of pride when he has had a hand in developing another great investor.

This concludes our six-part series on the ideal investor temperament. We’ve considered some of the traits that great investors have in common. I’d like to thank you, my readers for the fantastic response that I’ve received for this set of articles. It’s always fun to see how people all over the world respond to your ideas.