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 just one key, but rather five. The most successful investors seem to be equal parts optimist, pessimist, analyst, economist and psychologist. Together, I call these the five minds of the investor. If you can develop and balance all five, that—I believe—is the key to investment success.
1. Optimist. When I think of financial optimists, I immediately think of Warren Buffett. Now, you might imagine 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, 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 a 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 as Buffett wrote in that 2008 article, “Fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.”
Of course, you can’t have 100% of your money in stocks. That brings us to the role of the pessimist.
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 of each. You’ll notice 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 that 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 isn’t 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.
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 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.
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.
5. Psychologist. Last week, 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’re wrong or right is less important than the fact that such 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 believe you’ll tilt the odds in your favor.
Adam M. Grossman’s previous articles include Looking for an Edge, Divvying Up Dollars and Less Than the Truth. Adam is the founder of Mayport Wealth Management, a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter @AdamMGrossman.