One of my favorite Warren Buffett quips reads, “The most important quality for an investor is temperament, not intellect.”
Not a greater example of this exists than in the introduction of Morgan Housel’s fabulous book, “The Psychology of Money.”
In a nutshell, he describes two individuals.
One is a first-generation high school graduate and lifelong janitor and gas station attendant.
The other is a Harvard-educated and University of Chicago MBA graduate who was chosen for Crain’s “40 under 40” list of most successful businesspeople.
The first with little education; the second with the best education money can buy.
The first with zero formal financial experience; the second rose so quickly through the ranks at Merrill Lynch that the CEO praised his “business savvy, leadership skills, sound judgement and personal integrity.”
The first, Ronald Read, died in 2014 at 92. And this is where it gets interesting. Less than 0.15% of the people who passed in 2014 had amassed more than $8 million of net worth. Read was one of them. He left $2 million to his step-kids while the other $6 million of his fortune went his local hospital and library.
A few months prior to Read’s passing, the second man, Richard Fuscone, foreclosed on his 18,000-square-foot Greenwich, Connecticut, home. His Palm Beach home was foreclosed upon years prior and other possessions were repossessed as he worked his way through bankruptcy court and financial ruin.
This story is, of course, more about extreme financial discipline and patience versus extreme financial recklessness and ego than it is about investing per se, but the same type of discipline and patience is critical for a successful investing experience, and it’s far more important than creating the “perfect portfolio,” whatever that is.
First, the quest for a perfect portfolio is a fool’s errand, as there’s no such thing. But more importantly, it has almost nothing to do with an investor’s long-term financial success. In other words, a “perfect” portfolio that you cannot stick with is exponentially worse than a “just fine” portfolio that you’re comfortable with holding through thick and thin.
For instance, I can tell you the evidence strongly suggests that the small value asset class provides greater expected returns than the large growth asset class, albeit with more risk. In fact, I can tell you that the evidence is so strong for a small-cap value premium that the likelihood of small value outperforming large growth is about the same as the likelihood of stocks outperforming T-bills. Most everyone would take those odds – in theory.
But what happens when that small value tilt doesn’t work for a while? And then, for a longer while still? Do you decide that this time it’s different? Might you conclude that the big tech companies are clearly eating the world and the small-cap value premium is an antiquated strategy? Might you decide, in, say, September of last year, after continued small value underperformance, that it’s time to change course to a more growth-oriented portfolio?
What would that decision have cost you? Well, the S&P Small Value Index went up over 64% in the following six months. That’s right – 64% in six short months. Meanwhile, the S&P Large Growth Index rose just over 12% over the same time period.
I see two takeaways:
First, patience and discipline in an investment strategy is far more important than the strategy itself. It simply doesn’t matter how sound your investment strategy is if you get scared out of it. Patience and discipline earned investors 50 percentage points over six months, not intelligence or impulse or research or Morningstar ratings.
Second, regardless of what the academic evidence states, having a portfolio that you are comfortable with holding is a key component to exhibiting that ever-critical patience and discipline. Do you think Ronald Read had the “perfect portfolio?”
If you are uncomfortable with a certain investment, despite the evidence, think twice before owning it, as the best investors are always the ones who can stick with their investments.