Bill Ackman on the Psychology of the Successful Value Investor

Bill Ackman on the Psychology of the Successful Value InvestorFollowing the meltdown of the financial system in 2008, subsequent economic downturn, innumerable investigative journalism pieces about the big banks and investment practices, and finally the rise of the Occupy movement, it’s safe to say that finance and investing have taken a high-profile position in the mind of the public. People who wouldn’t know Freddie Mac from a hole in the ground four years ago are now paying attention to the meta-structure of the US economy in an unprecedented fashion.

Combine this with the meteoric rise of new tech companies in the last decade, such as Apple, Facebook, and Google, which routinely make headlines with news of IPOs and stock prices, and it’s safe to say that Americans are more critical of and interested in investment practices in general. We’re also entering a new era where potential investors can follow a company from its buzz-y birth, a la Groupon, to its debut on the public exchanges, and take an active part in becoming a part of a company that they themselves understand and use, far removed from arcane financial instruments utilized by hedge funds and investment banks.

In this light, retail investing, i.e. individuals buying stocks to build personal portfolios and plan for retirement, could well be entering a new era, as anyone with a laptop and an eye for business news can follow the information along with the rest of the market, along with a healthy dose of post-crash skepticism. But the age-old question remains: what makes a good investor? And how do the recent market woes affect the average person?

Burton G. Malkiel’s personal investment book A Random Walk Down Wall Street famously states that “a blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts.” This assertion is generally based on longitudinal studies showing that most successful professional investors will, over time, come closer and closer to the market average, despite earlier luck or innovative practice. (Makliel’s monkey dartboard notion became so popular that The Wall Street Journal ran over 100 simulated dartboard contests from 1988 to 2001. The results: inconclusive.)

So what’s an individual investor to do, if even the pros can’t demonstrably do better than random chance most of the time? Here’s Floating University lecturer William Ackman discussing a core conceit of successful investing:

In this view it’s all about psychology. Resisting group behavior and using patience to perform seemingly counter-intuitive investment actions pays off in the long run, as short-term fluctuations and losses can lead to long-term gains with a steady hand at the rudder and an eye to the horizon. This advice might be particularly applicable to a post-crash world, where fidgety markets have fluctuated wildly.

Michael Mauboussin, Chief Investment Strategist at Legg Mason Capital Management, says the following about risk-aversion post 2008 in the world of investment (from his Big Think Interview):

The first important thing to articulate is that when we enjoy a gain of a dollar and the loss of a dollar which are, of course, symmetrical, we tend to suffer two to two and a half times more from the loss then we enjoy the gain, so there’s this asymmetry of suffering versus joy in financial matters that’s important to lay out . . . .

I will say I think you’re on to a really important thread, which is the bottom line is that people that are very outgoing and people oriented and attuned to other people’s emotions tend to have a difficult time investing because they feel most comfortable as being part of the group. People that tend to be more reserved, more independent, less attuned to people emotionally, tend to be better investors. So it’s not a judgment call because some of these—I don’t know if you want to call them skills—but these natural tendencies may not serve you well in other facets of your life.

The more psychologically attuned to other people you are, the more you might subconsciously allow your decision making to be guided by group-think, which makes for a difficult line to walk in the world of investment. Attune your psychology to recognize the motives of market movements, but maintain enough restraint to resist the urge to follow along.

With this psychological framework in place, try the following thought experiment: Assume you just won $100,000 in the lottery.  How would you invest it? What would you do if you were responsible for investing the endowment of your college, or on the behalf of a deceased family member’s estate? How would this differ from how you might invest the money you won in the lottery? Why?