Monday, May 23, 2011

Ritholtz: The Many Hats of Great Investors

Barry Ritholtz, from The Big Picture blog, has been posting some great stuff in his gig at the Washington Post.  I highlighted this piece a few weeks ago [May 9, 2011: When to Fire Your Mutual Fund Manager] and over the weekend we have his latest - The Many Hats of Great Investors.   Worth the full read, I'll post the highlights below - but it definitely showcases the part of the market I like.  That is, how it's essentially a multi dimensional 4 dimensional "game" of the highest order, like chess.  And it only seems to get more complicated by the year with outside involvement by central bankers, and internal advancements by players of the silicon kind.  (Although at times like this it is pretty simple - tell me where the dollar goes, and I can tell you more or less how everything else will move!)

As I've stated in this piece [Dec 31, 2010: The Year Ahead and Times Gone By] when I first came to the market in a serious way, I thought I could just analyze it to pieces, and break it down mathematically and it was as simple as that.  If that was true, statisticians and engineers would be the greatest investors - rather than people from all sorts of backgrounds, including liberal arts.  Barry explains below!


  • From the next generation of Warren Buffett wannabes, I occasionally hear questions such as “What should I learn to become a great investor?”  Contrary to popular belief, investing isn’t a traditional academic discipline. Money management is hardly a typical major. There are, of course, plenty of “Business Administration” undergrads, but their focus tends to be on running companies, rather than investing in them.  
  • We churn out MBAs like made-in-China widgets, yet few ever become outstanding investors. And don’t even ask about economists — the profession that missed the housing boom and bust, the Great Recession, the credit crisis and the market collapse.
  • Great investors are savvy generalists. I can think of five fields that are hugely helpful to asset management. If you were to study these disciplines, your understanding of how markets work would greatly improve. And you would be a better investor.
  • How? You will generate better risk-adjusted returns; meaning, you will get the most bang for the bucks you are putting at risk. You will suffer less from volatility — the stomach-churning ups and downs in the markets that are one part risk, one part opportunity. And you will avoid the typical mistakes that most investors make.

The five disciplines that can help:
  • Historian: Knowing what has happened in the past (and how often) is an enormous advantage when it comes to investing. It informs you of the range of possibilities, allows you to conceptualize possible outcomes to various scenarios and provides a framework for thinking about market cycles.
  • Psychiatrist: Fear and greed are the most enduring investor emotions. They lead to destructive behaviors. Not understanding your own psychology is the downfall of many an investor. The best financial plan becomes worthless if you are unprepared for the emotional turmoil that accompanies the ups and downs of markets.  The crowd becomes an unthinking mob at tops and bottoms. Being able to read the emotional state of the market, as well as keeping your own emotions in check, are hallmarks of great investors.
  • Trial lawyer: Good litigators are always skeptical, but not negative. Like a good litigator, you must question data, consider alternative explanations, argue against the obvious. You cannot blindly accept everything you hear as truth, nor can you reject everything out of hand. Being able to discern between information that is valuable and that which is not, is crucial.
  • Mathematician/statistician: Investing is filled with math: compound interest-rates, dividend yields, long-term gains, price-to-earnings ratio, risk-adjusted returns, percentage draw downs, annualized rate of returns.
  • Accountant: An understanding of basic accounting is essential to grasping the fundamental health of a company or business model. It is how you determine whether an existing company is profitable, or when a young firm might become profitable. But it also can help you determine when a formerly profitable company is heading down the wrong path. You don’t have to be a forensic accountant.

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