So you have a grand vision for becoming the next great investor like Carl Icahn, Steve Schwarzman, Bill Ackman, or Warren Buffett? Many of the public articles on this topic are cursory and aimed at driving clicks with no real substance as to what it takes to become a truly great investor. Valuable financial knowledge is hard enough to come by. Would be financial titans need to overcome a lack of knowledge, the trouble of identifying good instructors, and conduct an exercise of filtering through mountains of informational noise.
Maybe it is too harsh to say that all the clickbait articles are lying to you, but they certainly speak much and say little. But it is not realistic to assume that the collective wisdom of the greatest minds in capital markets will be coalesced into a single concise web page. This is wishful thinking.
To become a great investor you should probably first understand what it takes to become a merely average investor. Then from that level of perspective ask yourself, what separates an average investor from a great one? Have you considered that the difference between an average investor and a truly great investor may be more than an order of magnitude better than your current understanding? It must be.
Something so far removed from what you currently know might seem unreal, unobtainable, at least without more fundamental knowledge.
The science-fiction writer Arthur C. Clarke famously posited three laws related to his observations of scientific discovery.
- When a distinguished but elderly scientist states that something is possible, he is almost certainly right. When he states that something is impossible, he is very probably wrong.
- The only way of discovering the limits of the possible is to venture a little way past them into the impossible.
- Any sufficiently advanced technology is indistinguishable from magic.
Finance is a science. And the people leading the pack regularly represent the second law in action. To outsiders without knowledge of what they do or how they do it, the third law applies.
Now ask yourself, if you discover that this gap between you and the people you want to be like is far greater than you imagined, will you even start that journey? Most people can probably answer this question instinctively and will find themselves unhappy at the conclusion.
Why are some investors so successful?
Folks who come to an optimistic or happy inference about their capabilities will also realize that these current leaders are just people. In most cases, they have no special powers above what the average person possesses.
When it comes down to it, everyone in every position of power or prestige is just is a mere mortal. They will make mistakes, and get sick just like the rest of us. And, for those unaware, human intelligence has been proven to be roughly homogeneous across nearly every geography.
The differentiating characteristics between good and great investors are a combination of quantity and repetition and to develop ‘superior’ skills as a result of their activities. These differences can be defined simply as:
- More skill as a result of practice
- More knowledge
- Superior habits
- Superior environment
Each of these items is built around repetition. The adage practice makes perfect is true in investing.
More skills are a result of practice – What are the skills that the best investors have?
Wayne Gretsky, is an extreme outlier in goals and assists in the NHL, so much so that it looks like an error on a regression graph. As a youth, he started skating younger than most kids, skated more frequently, and stayed on the ice longer each day because he loved it. The story of many financial paragons of today and yesteryear are similar.
Investing is a skill borne from applied science. Like ice hockey, the folks who get started earlier, practice it more often, and love it will probably perform better over the long run. Sometimes investors might even produce outcomes that look like an outlier.
To begin with, every great investor has to develop the skills and habits of someone who will earn the average market return. After that point, they need to know themselves well enough to understand if they have the innate desire to focus on investing day in and day out. Then actually do it.
After that basic level of mastery has been achieved, you must build the advanced skills necessary to achieve investment objectives whatever they may be.
At a fundamental level, consider the fact that every person on the planet is subject to (at least) two laws of the financial universe:
- Compounding.
- Behavioral psychology in markets.
It is a law of nature that compounding in markets favors those with (1) more capital, (2) more knowledge, and (3) better-practiced skills and well-formed habits. The effects of compounding produce large results. The effects can be logarithmic when the other elements are combined, it will always be this way.
It is a given that human beings are not perfect. Human error is an ever-present part of life. We’ve all met that business owner, doctor, or lawyer spending money like it’s going out of fashion. The flaws inherent in human nature create opportunities in financial markets. Winners and losers abound as a result.
Compounding capital and reducing error play a central role in the skill of an investor. Let’s compare the skills needed to be average against the skills needed to be great:
What are the essential skills required to be an average investor? There are perhaps five skills required to get at least the average or close to a market rate of return.
- Fundamental understanding the nature of compounding.
- Basic understanding of the correct definition of investment risk.
- Basic knowledge of how financial markets work.
- Basic understanding of the difference between different available financial instruments.
- Basic understanding of the basics of behavioral finance.
What are the essential skills required to be a great investor?
- 1-5 above
- Extreme financial literacy (including the ability to read all the financial statements).
- Deep knowledge of accounting and tax matters.
- Specialized knowledge about an industry or market.
- Mastery of behavioral finance.
- The ability to form new habits and turn old ones into virtues.
- The ability to compound knowledge.
The gaps from average to great won’t seem so tectonic once an investor understands how to achieve the market rate of return. Each of the steps beyond this point is only a superior skill developed as a result of practice and a habit formed as a result of repetition.
It is within the capacity of every average investor to develop those skills one at a time. Many of the most well-known figures in finance have taken their skills to demonstrable extremes of human capacity.
More Knowledge – What the best investors know that you don’t.
If everyone were equally knowledgeable about investing then everyone would earn the average return. Thankfully this isn’t the case. See our discussion on the paradox of investment skill and why this can’t and won’t be the case now or in the near future.
We have established that a fundamental or at least foundational understanding of investing is a necessary prerequisite to at best not lose money or get swindled.
Great investors are not smarter than you. But they certainly know more than you do. A four-year double major in finance and accounting at a prestigious university and masters or Ph.D. in finance would not be enough knowledge to make someone a great investor. Maybe an average investor, but not a great one. Markets are too competitive.
One man’s trash is another man’s treasure. If a buyer knows far more than a seller about the present or future value of a business, commodity, or security a profit opportunity exists.
As long as an investor retains disproportionate or asymmetric knowledge about many investments there may be an asymmetric opportunity to profit over many years. The key is knowledge.
There are three components to knowledge identified by Swiss psychologist Jean Piaget in his study of child development. Viewed from the window of investment knowledge these are:
- Physical knowledge: facts, features, and characteristics of a thing. US Steel produces cold-rolled steel. Coca-cola ships billions of units annually. Capital light businesses can generally reinvest at higher rates of return. IBM’s stock price is X. This is information that can be gathered and consumed by observing the qualities of businesses and commodities.
- Social knowledge: Names and conventions, made up of people and only demonstrated by others. Elon Musk is a visionary CEO. Jamie Diamon is one of the best banking CEOs on record. Peter Theil is a contrarian investor.
- Logico-mathematical knowledge: Is the creation of new relationships between social and physical knowledge. As the neurons in the brain build out billions of connections for knowledge acquired and stored the brain builds new associations and enhance related associations. Some connections that have never existed before in nature. This is a physical and electrochemical interaction that others cannot see. Wisdom knowledge is a form of collective logico-mathematical knowledge.
The best investors are regularly taking in asymmetric amounts of information related to social and physical knowledge associated with an area where they have particular competence. The best investors work to expand knowledge competence and only act when they have asymmetric information playing out in their favor. In the below section on habits, we discuss what this data gathering process looks like.
Superior Habits
You learn to read at a young age by reading the same children’s book over and over again. Observe even the youngest children with their favorite book and they will know the parts of the narrative by heart even if they don’t know the words yet. As children age, they graduate to bigger more complex books and then into the world of concepts.
As the brain develops it is building out a latticework to recall the different types of knowledge and then command it in speech, action and ultimately form new associations. The brain, like a muscle that can be trained, is malleable until dysfunction or death. The brain has enough capacity to store more than 300 years of daily use data.
The best investors are exploiting this natural capacity and building habits for collecting and storing data. The natural consequence of which is lots of well-built connections to and among the data points.
A major percentage of adults don’t read another book after college. A smaller percentage are reading every day. Investors as a class don’t read the financial reports or annual statements of the companies they ‘invest’ in. Even fewer will conduct proper diligence. Now imagine the number of investors trying to do it with an informational edge. You can quickly see the number dwindles to a minuscule population.
Reading aggressively and habitually to accumulate knowledge is the first superior habit that the best investors have.
“I read and think,” …. “So I do more reading and thinking, and make less impulse decisions than most people in business. I do it because I like this kind of life.”
Warren Buffett
A quick breakdown of successful investors and entrepreneurs shows this habit to be common:
- Warren Buffet reportedly spends 80% of his day reading.
- Bill Gates reads about 50 books a year.
- Mark Cuban reads more than three hours a day.
- Elon Musk has regularly commended “I read books”
Buffett reads six newspapers a day, including The Wall Street Journal, Financial Times, The New York Times, USA Today, Omaha World-Herald, and American Banker among other publications.
How much reading should be done each day? Warren Buffett suggests that anyone aiming to achieve a similar level of success should read around 500 pages per day. The math is a staggering amount of time.
But, this level of habitual reading would eventually produce an asymmetric informational advantage in a market landscape. The data the best investor consume is generally of a context relevant to their field of practice.
While there are other habits that could be evaluated in this post. Such as screening investments, exercise, etc.; this is the most important and fundamental superior habit of great investors.
Superior environments
What does it take to facilitate this much reading? What environment fosters great investing ?
Skill and habits alone do not a great investor make. The environment you belong to or create for yourself matters too. We don’t mean to argue in favor of nature or nurture. That is a flawed line of thinking, as each person is different and will respond to different stimuli differently.
But, clearly, an environment where you can repeatedly build knowledge and reinforce what you learn is just as critical as is having access to that knowledge.
There is more information available in one issue of the Wall Street Journal than a Bedouin nomad in the Arabian peninsula will receive in his whole life. Environment matters as an absolute condition.
The greatest investors have a daily route that allows them to focus only on their desired skills (investing) and allows them to compound knowledge as much as their own money. Superior investors build environments for themselves that remove distractions and are only focused on the best, most relevant information.
Put a brick through your TV (or maybe just don’t have one in the office or at home). The talking heads can’t give you information as fast or concisely as you can consume it by reading it.
What Great Investors Do On A Daily Basis: The Daily Routine Of A Great Investor
The scraps of news reports that share what a day in the life of these investors do supports the reading habit and environment.
Ted Weschler both ran a successful investment fund and now manages billions in capital at Berkshire. When asked about his day he stated:
“It’s terrific. In many ways, it doesn’t change much from my prior world, where I ran a fund … I’ve always been kind of a one man band, analytically. I spend the vast majority of my day reading. I try to make about half of that reading random. Things like newspapers and trade periodicals.”
Todd Combs, who shares a similar background shares his day:
“I get in around 7 or 8, and I read until about 7 or 8 at night … And I go home, and see my family, and then I’ll read for another hour or two in bed at night. And you know, there might only be three to four phone calls the entire week. So there are very, very few interruptions. I have a great assistant who knows everything that I read, and she kinda provides everything, and there’s a back and forth between us where I’ll mark it up, and give it back to her. And we have a system for filing and so forth. But it’s literally just reading about 12 hours a day of everything I just mentioned.”
Their reported reading lists include:
- Financial Times
- New York Times
- USA Today
- Wallstreet Journal
- 250 public companies per quarter
- SEC Filings
- Transcripts (transcribed)
- Trade magazines
And they do the diligence to conduct channel checks and call on:
- Customers
- Suppliers
- Ex-employees
As if they were going to acquire the entire business.
To Be An Exceptional Investor You First Need To Be Average First
Reading this you should be a little overwhelmed. At least, if you are thinking properly about what has just been presented. The time and environment required to accomplish this is difficult to establish. And, just being an average investor is easier said than done. But it’s the best starting point.
But, once you have accomplished your goal of being average, working diligently to reduce the gaps between what it takes to be great is only an incremental step.
