i3 Insights: In Search of Temperament

It’s been ten months since we launched the i3 Insights podcast. We’ve talked with guests from a variety of backgrounds including quants, academics, growth investors, value investors and many more. Looking back, we’ve notice that a common theme has emerged across our conversation with some very different people: the importance of temperament for investment success.

Temperament usually comes up when discussing investment decision making. The word is often used, but seldom defined. This is the first in a series of posts where I offer my definition of a successful investor’s temperament.

I’m not going to write about integrity, honesty, truthfulness, etc. Not because these qualities are unimportant. Far from it, they are the bedrock on which trust is built. Trust is essential to investing. Investing involves making decisions about the future, which is always unknown. It’s impossible to do this without a degree of trust in the people making the decisions and in the investment process.

I’m also not going to talk about personality.  An investor’s temperament has little to do with whether or not they’re an extrovert or an introvert.

Temperament, in the investment sense of the term, is how we deal with the uncertainty that comes with making decisions about the future. It is the way that we make decisions based on incomplete information where the results will often be unknown for a long time.

With this definition in mind, I believe that temperament includes the following:

  • Curiosity
  • Flexibility
  • Contrarianism?
  • Patience
  • Self-awareness
  • Self-control
  • Probabilistic thinking
  • Your attitude toward mistakes
  • How you measure success
  • How you treat others

Curiosity

Curiosity helps investors in many ways. Investing requires constant learning. It’s hard to learn if you’re not curious. Curiosity prompts investors to search for facts and to reason on them. It’s also the sign of intellectual humility. A person who knows everything is rarely curious.

Most importantly, curiosity is the engine that drives the compounding of knowledge. Most of us are familiar with the way that compound interest grows the value of an investment. Knowledge also compounds. No investor is born smart, they become smart by acquiring knowledge and experience. It’s curiosity that helps them get there.

I’ve been lucky enough to meet thousands of investors from around the world from many different countries and backgrounds. The best investors are always curious.

How can you spot a curious investor? They read. A lot and all of the time. They are usually interested in a wide variety of topics. They not only collect facts but they also find ways to link them together. They test what they learn, often by seeking out facts and people that run contrary to their current views.

Curious investors demonstrate personal growth over time. This is due to the compounding effects of learning discussed earlier. They are also willing teachers since they understand the value of knowledge and therefore want to help others learn.

Flexibility

A curious person is an explorer. Consequently, they are likely to encounter a lot of situations where their opinions and beliefs need to change. That’s why flexibility goes hand in hand with curiosity. Think about it, an investor is not going to actively search out new facts and ideas unless they are open to changing their opinions and beliefs.

Why is flexibility so important? Again, it comes back to the fundamental problem that investors have to deal with: uncertainty. Course corrections are inevitable when making decisions about the future. There’s so much we don’t know because it hasn’t happened yet.

Flexibility also has its problems. One of the difficulties of being flexible is that many people equate changing your mind with inconsistency and a lack of understanding. Flexible thinkers often sound unsure because they actively entertain the possibility that they could be wrong and/or that they may need to change their minds.

There’s also the risk that flexible people bounce from idea to idea. Performance chasing is an example of this kind of harmful flexibility. Successful investors guard against this risk by recognising that the need to be flexible isn’t constant.

For example, attributes and circumstances often change, so more flexibility makes sense. In contrast, general principles tend to be based on enduring truths. Changing your mind about these truths requires a higher standard of evidence and logic.

Benjamin Graham was an excellent example of this idea. Graham is widely recognised as one of the founding fathers of value investing. He taught his students the value of general principles, such as investing with a margin of safety.

But as Jason Zweig observed during our interview, Graham was flexible when it came to the specifics of how to implement his ideas. Each edition of his textbook Security Analysis contained revised valuation metrics. Graham always stuck to his principles, but he updated his methods to reflect the circumstances.

How can you spot a flexible thinker? Flexible thinkers can easily argue the other side of an issue. Once again Graham is a perfect example. Graham spent his career looking for mispriced stocks and teaching his students to do the same. Yet, he was also one of the earliest practitioners to realise that the stock market is “efficient” in a practical sense.

In a film, which premiered on 1 February, 2013 at the 16th Annual Columbia Student Investment Management Association Conference, and old clip of Graham is shown answering a question about why Wall Street professionals are not more accurate in their forecasts. Graham answers:

Everybody on Wall Street is so smart that their brilliance offsets each other and whatever they know is already reflected in the stock prices and consequently what happens in the future represents what they don’t know.

Flexible thinkers rarely talk in absolutes. They commonly answer questions with “it depends on…” followed by a framework that joins together the variables that they believe matter. Flexible thinkers tend to be less concerned about what other people think. Always deferring to consensus or the status quo would rob them of their flexibility. They tend to be poor salespeople but good educators. It’s tough to sell an idea that’s constantly changing. In contrast, flexible thinkers make great teachers because they consider a wider range of ideas and information.

You might be wondering: Does a curious and flexible temperament mean that an investor will also be a contrarian? I’ll explore this topic in my next post.

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