In Investing, Temperament Trumps Talent

About Latest Posts Scott PhillipsScott Phillips is The Motley Fool's Chief Investment Officer in Australia. He is Advisor of The …

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Last week, the S&P/ASX 200 closed at 4645 points. The previous Friday, the index had closed at 4864 – a fall of 4.5% in only 5 trading days. Only 16 trading days earlier, the index had closed at 4938 – a total fall of almost 6% in just over 3 weeks.

In the 5 trading days until last Friday, BHP (ASX: BHP) had fallen 6.5%, Woolworths (ASX: WOW) had dropped 2.2%, Commonwealth Bank (ASX: CBA) was down 3.4% and Telstra (ASX: TLS) had fallen 6.0%. (Of those, BHP went 'ex-dividend' during last week, explaining some of its fall).

For a market that has been on a steady upward trend since the dark days of March 2009, the last month or so has been something of a shock. If you've only started investing in the last couple of years, the past few weeks would have been an uncomfortable lesson that the market can go down as well as up.

For most of us who endured the 2008-9 bear market, it might have been an unwelcome reminder of that time – and may well have renewed questions of whether or not the stock market was a place for the individual investor, and whether we were smart enough to be successful.

Brains = Success?

It would be fair to assume that to be a successful investor; you have to be pretty smart.

In fact, given the legion of investment bankers, financial commentators and professional investors – not to mention the dozens and dozens of analyst reports produced every single workday – anyone without a stratospheric IQ should give up, right?

You'd be forgiven for thinking so, but here at The Motley Fool Australia we couldn't disagree more. And happily for us, we're in pretty good company.

Oracle of Omaha

You've probably heard of Warren Buffett. If you're late to the party, don't worry – there are plenty of Foolish resources (including here and here) to get yourself up to speed.

In short, many people think Warren Buffett is the world's greatest investor. What we know is he's the third richest person on the planet.

When Buffett speaks, Fools don't always agree, but we certainly listen! Warren Buffett famously told BusinessWeek back in 1999:

"Success in investing doesn't correlate with IQ, once you're above the level of 125. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing."

Now, I can't speak for Warren Buffett, but I'm pretty sure he wasn't suggesting that if you have 'ordinary intelligence', investing is a cinch. What I think he was saying is that successful investing requires more than just raw brain power.

Beating the Street

Another very, very successful investor is Peter Lynch. Lynch ran the Fidelity Magellan Fund in the US for 23 years, returning an average 29% per annum over that time. Lynch wrote in his book, Beating the Street:

"Everyone has the brainpower to make money in stocks. Not everyone has the stomach. If you are susceptible to selling everything in a panic, you ought to avoid stocks and stock mutual funds altogether"

As wildly successful experts in their chosen field, Messrs Buffett and Lynch could have dazzled us with jargon and tales of sophisticated algorithms that only they could understand.

They could have told us about how difficult this investing caper is, and made themselves seem all the more impressive to have overcome the odds through application of super-human intelligence.

Not only do they not claim genius status (though it may be fairly conferred on them), both men separately tell us that there is something far more important than a sky-high IQ – temperament; the ability to be rational and considered and to stay calm in the face of uncertainty.

By way of contrast, a company called Long Term Capital Management was probably the most spectacular US corporate collapse of the 1990s. Among their best and brightest were two Nobel Prize winners – and yet the business still lost many billions of dollars despite their combined experience and intellect.

Don't Follow the Crowd

When in a crowd – at a rock concert, football game or during a disaster – humans have been conditioned by millions of years of evolution to take our cues from those around us. Our distant forebears ran when others around them were running, without waiting to see the lion with their own eyes. So it's no surprise that modern humans are hard-wired to respond to the activity around us.

The challenge for Homo Investus is to recognise that crowds can – and frequently do –overreact. If you see others running from a lion, there's no harm in running just in case… the downside risks make that option a slam dunk.

But as an investor, Warren Buffett reminds us that his success has come from an approach of being:

"…fearful when others are greedy, and…greedy when others are fearful."

It can be incredibly hard to ignore the emotions and action around you. The financial and popular press on television, newspapers and the internet provide almost hourly updates of the gyrations of the markets. It's easy to ascribe some sort of special meaning to the ups and downs, believing that each tenth of a percentage point actually means something.

Have the Courage of your Convictions

Unlike our ancestors who dealt with mortal threat on a regular basis, we have the luxury of time – to stop, think and choose whether to we need to act. We can choose to hold our ground when those around us are running. We can be wary, even while those around us celebrate, blind to the risks. As long as your analysis is sound, this unpopular act can give you the edge over the crowd – of amateurs and professionals alike.

The challenge – and it is a challenge – is learning to ignore the noise and focus only on what matters.

Business quality and a fair price will determine your success over the long term – having the temperament to take advantage of hopeless pessimism and ignore heady optimism will keep you out of trouble.

Fool contributor Scott Phillips owns shares of Woolworths and Telstra.

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