As an individual investor, what’s the key to success? It’s a question I hear a lot, especially in volatile times like this.
The answer, I think, is that there isn’t one key; there are many—five actually. The most successful investors seem to be equal parts:
Together, I call these the five minds of the investor. To the extent that you can develop, and balance, all five—that, I believe, is the key to investment success. Below is an introduction to each.
No. 1 – Optimist: When I think of financial optimists, I immediately think of Warren Buffett. Now, you might think that it’s easy to be an optimist when you’re a billionaire, but I think it’s precisely because Buffett is an optimist that he’s a billionaire. His secret—which really isn’t such a secret—is to bet on the long-term growth of the stock market. During his company’s recent annual meeting, despite an overall report that wasn’t great, Buffett stated, “The American miracle, the American magic has always prevailed, and it will do so again.”
Buffett sounded a similar note during the last recession. In October 2008, when things looked terrible as far as the eye could see, Buffett had this to say: “Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”
When the economy is in recession, as it is today, with millions out of work, it’s easy to feel dispirited. It is scary, and I don’t want to diminish everything that’s going on. But the key here is to follow Buffett’s lead—and not just because he says so. In that 2008 article, Buffett was clear that you shouldn’t assume stock prices will rise in the future just because they’ve risen in the past. You should assume that stock prices will continue rising because of math, which he provided in his article. That’s what should give you the confidence to be an optimist, like him, and to keep investing, even when things look bad.
Of course, you can’t have 100% of your money in stocks, and that brings us to the role of the pessimist.
No. 2 – Pessimist: Many people view themselves as either a glass-half-full or glass-half-empty kind of person. But for investment success, I think you want to be a little bit of each. You’ll notice above that Buffett referred to the stock market’s long-term potential. That’s an important qualification. As we’ve seen this year, things can, and do, happen to interrupt the market’s growth. That’s why it’s important to pay as much attention to your inner pessimist as to the optimist. What’s the best way to accomplish that? It’s not complicated: You just want to keep enough of your assets outside of stocks to help you weather these interruptions. That will give you both the financial ability and the mental fortitude to get through tough times.
No. 3 – Analyst: If the optimist believes that stocks will grow over time, and the pessimist knows that they can’t grow all the time, how do you balance the two? That’s where the analyst comes in. The role of the analyst is that of mediator—to consider the needs of both the optimist and of the pessimist. Your inner analyst should be dispassionate, focusing on the facts of your individual situation. This includes your income, expenses, assets, liabilities, and goals. In short, the analyst’s job is to strike the right balance between optimism and pessimism to develop an investment strategy that’s the best fit for you.
No. 4 – Economist: As I’ve noted before, economics isn’t exactly a scientific field, and anyone’s ability to forecast the future is necessarily limited. But successful investing does incorporate certain economic concepts. At a high level, these include fiscal policy (the government’s ability to set tax rates and spending levels) and monetary policy (the Federal Reserve’s ability to set interest rates). It also includes, more recently, the Federal Reserve’s growing role as financial backstop of last resort. And finally, it includes a sense of economic history and financial cycles. None of this means you’ll be able to predict where the economy is going. None of us can. But it does mean you’ll be better equipped to respond to events as they occur.
No. 5 – Psychologist: Yesterday I heard a well known investor state that the stock market is in a bubble and that “it will end in tears.” This reminded me of a prediction, from another well known investor who, back in March, warned that “hell is coming.”
Whether they are wrong or right is less important than the fact that colorful commentary and dramatic predictions are all around us. That’s why the fifth, and maybe most important, ingredient for investment success is to channel your inner psychologist. Among other things, this will help you to understand the motivations—both conscious and unconscious—of others and to see the subtext of what they’re saying—and not saying. This will help you to tune them out, as needed, so you can stick to your plan.
Is investing easy? No, I don’t think anyone would (truthfully) claim that. But if you successfully balance these five ideas in your mind, I do believe you’ll tilt the odds in your favor.