Your knee hurts, so you pay a visit to your favorite orthopedist. He smiles, maybe even gives you a hug, and then tells you: “I feel your pain. Really, I do. But I don’t treat left knees, only right ones. I find I am so much better with the right ones. Last time I worked on a left knee, I didn’t do so well.”
Though many professionals — doctors as well as lawyers, architects and engineers — get to choose their specializations, they rarely get to choose the problems they solve. Problems choose them. Investors enjoy the unique luxury of choosing problems that let them maximize the use of not just their IQ but also their EQ — emotional intelligence.
Let’s start with IQ. Our intellectual capacity to analyze problems will vary with the problem in front of us. Just as we breezed through some subjects in college and struggled with others, our ability to understand the current and future dynamics of various companies and industries will fluctuate as well. This is why we buy stocks that fall within our sphere of competence. We tend to stick with ones where our IQ is the highest.
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Though we usually think about our capacity to analyze problems as being dependable and stable over time, it isn’t. It might be if we were characters from Star Trek, with complete control over our emotions, like Mr. Spock, or who lacked emotions, like Lieutenant Commander Data. This is where our EQ comes in.
I am not a licensed psychologist, but I have huge experience treating a very difficult patient: me. And what I have found is that emotions have two troublesome effects on me. First, they distort probabilities; so even if my intellectual capacity to analyze a problem is not impacted, my brain may be solving a distorted problem. Second, my IQ is not constant, and my ability to process information effectively declines under stress. I either lose the big picture or overlook important details. This dilemma is not unique to me; I’m sure it affects all of us to various degrees.
The higher my EQ with regard to a particular company, the more likely that my IQ will not degrade when things go wrong (or even when they go right). There is a good reason why doctors don’t treat their own children: Their ability to be rational (properly weighing probabilities) may be severely compromised by their emotions.
A friend of mine who is a terrific investor, and who will remain nameless though his name is George, once told me that he never invests in grocery store stocks because he can’t be rational when he holds them. If we spent some Freudian time with him, we’d probably discover that he had a traumatic childhood event at the grocery store (he may have been caught shoplifting a candy bar when he was eight), or he may have had a bad experience with a grocery stock early in his career. The reason for his problem is irrelevant; what is important is that he has realized that his high IQ will be impaired by his low EQ if he owns grocery stocks.
There is no cure for emotions, but we can dramatically minimize the impact they have on us as investors by adjusting our investment process. First and foremost, investors have the incredible advantage of picking domains where they can remain rational.
For instance, I would not be able to keep a cool head if I owned gold. I can recite the arguments for and against gold (lately, with negative interest rates in certain European countries, the “for” arguments have started to make even more sense). But, intellectually, I cannot reconcile the fact that gold is an asset that generates no cash flows, and thus to me it has no financial center of gravity. I have no idea what it is worth. The very idea of owning gold bothers me, and therefore I know that if I did own it, my EQ would be low. I’d be buying high and selling low. But as a value investor, when I buy a stock and it declines 30 percent, I want to buy more of it (assuming its business has not changed). I wouldn’t trust that I could do this in the gold market.
To be a successful investor, you don’t need Albert Einstein’s IQ (though sometimes I wish I had Spock’s EQ). Warren Buffett undoubtedly has a very high IQ, but even the Oracle of Omaha chooses carefully his battles; for instance, he doesn’t invest in technology stocks.
Investors have the luxury of investing only in stocks for which both their IQ and EQ are maximized, because there are tens of thousands of stocks out there to choose from, and they need just a few dozen.
Meanwhile, I hope when I go see the doctor, he will tell me, “I don’t do left knees,” because the best result will come from a doctor who while treating me will utilize both IQ and EQ.
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Musical Note: Before I get to my musical note, I want to share with you an incredible TED talk by Benjamin Zander, “The Transformative Power of Classical Music” (watch it here). Mr. Zander makes the point that “Everyone loves classical music; they just don’t know it yet.”
I was asked recently by a reporter why I include classical music and my father’s art with my articles, and what the reader feedback has been. Here is what I answered:
One day I started sharing classical music with my readers. I just did. Not sure why. When I psychoanalyze that decision I find many reasons, and I’m not sure I can point to a single one.
But here’s a list of them, just off the top of my head:
(1) I truly love classical music. Its longevity fascinates me. We still listen today to music that was composed hundreds of years ago.
(2) Writing about classical music forces me to learn more about it. Even before I started writing about it, I was considering auditing a music appreciation class at the local university. Now I have an excuse to learn!
(3) I really enjoy getting readers’ feedback and their suggestions. Many of my readers know more about classic music than I do, so I get to learn from them.
(4) Since I write about it, now I can justify spending hours on Youtube listening to various performances.
(5) I love investing, and I love writing about it. But sometimes I feel it consumes too much of me. Writing about other subjects that are sometimes personal in nature, be it music or a trip to Santa Fe or Key West, is a nice diversion. Life is too short to spend it thinking only about investments.
The response I have received so far has been terrific. Those who don’t care about classical music just skip that portion of the email. But a lot of people want to learn more, and I provide an opportunity for them to do so. For others it is just excuse to listen to some beautiful music.
About art: I wanted to share my father’s art. I wanted others to see it. Now, if I forget to include one of my father’s pictures, I get emails along the lines of “Vitaliy, your articles are okay, but please don’t send them without your father’s art.”
Now the musical note: I only recently discovered Antonin Dvorak’s music. I’ve shared an aria from the opera Rusalka in the past (you can listen to Leontyne Price singing “Song of the Moon” here.
A few weeks ago I discovered and fell in love with a new piece by Dvorak: Symphony No. 9, also known as “The New World Symphony” (okay, it’s new to me). Part 2 of this symphony sounds very Irish. You be the judge: go to the 11-minute mark. Neil Armstrong took a recording of this symphony to the Moon on the 1969 Apollo 11 mission.
Here are two wonderful versions:
By Vitaliy Katsenelson, CFA / Institutional Investor Magazine
Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo. He is the author of Active Value Investing (Wiley) and The Little Book of Sideways Markets (Wiley).