Investing in the stock market is often made out to be an activity only highly intellectual Wall Street analysts should engage in. After all, someone who cannot calculate pi to the power of a gazillion in their head has no business investing in the stock market, right?
Wrong. In fact, that statement is so far from the truth it needs to use the Hubble telescope to even get a glimpse of reality. As Peter Lynch explains, "If you can add two and two together and get roughly close to four, you have the intelligence needed to make money from the stock market." Warren Buffett (Trades, Portfolio) of Berkshire Hathaway Inc. (BRK.A, Financial) (BKR.B) clearly agrees with this sentiment since he has often said, "The most important quality for an investor is temperament, not intellect."
What does that mean? And is it true that you do notneed to be the second coming of Einstein to invest in the stock market? Read on to find out.
Temperament over IQ: Buffett's perspective
Buffettt, considered one of the greatest investors of all time with a net worth of over $100 billion, does not attribute his success to having a high IQ. In fact, he believes temperament is far more important than intellect to succeed as an investor.
He once said, "Success in investing doesn't correlate with IQ. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble investing."
This idea is echoed by Michael Mauboussin, director of research at asset management firm BlueMountain Capital. In his book, "More Than You Know," he wrote, "Investment philosophy is really about temperament, not raw intelligence. In fact, a proper temperament will beat high IQ all day long."
So what does temperament have to do with investing success? Markets constantly test investor discipline through periods of poor performance and volatility. Many investors struggle to stick to their long-term strategy during these times, often giving in to emotions like fear and panic. However, the world's most successful investors have the rational temperament to ignore short-term noise and stay committed to their strategy.
Buffett himself is renowned for his ability to detach emotions from investing decisions and stick to the long view. This temperament allows him to capitalize on market declines as buying opportunities while others are fearful. Patience and rationality triumph over intellect in his approach.
The amateur's edge: Peter Lynch's view
Lynch had one of the best track records of any fund manager while running the Magellan Fund at Fidelity Investments from 1977 to 1990. But he does not credit his investing success to being smarter than everyone else. In fact, he believes amateur investors have a better chance of success than Wall Street professionals.
In his books "One Up on Wall Street" and "Learn to Earn," Lynch explains how individuals have an edge because they can spot investment opportunities right in front of them before the so-called experts. Examples he provides include noticing new franchise locations popping up in your neighborhood (Taco Bell, now part of Yum Brands Inc. (YUM, Financial), was one of his best investments) or enjoying an innovative new product or service in your daily life.
These simple personal observations and experiences give individual investors an advantage in spotting trends and changes early. While Wall Street analysts crunch numbers and pore over financial statements, amateurs can uncover the next big investment simply by keeping their eyes open.
Of course, these initial observations should be validated with research. But according to Lynch, individuals can absolutely gain an edge over professional investors by leveraging their everyday lives. Intellect and complex analysis are not prerequisites.
Further, Lynch believes that investing is more art than science. This means individuals can rely on common sense and basic research rather than advanced degrees or intricate quantitative analysis.
Noticing new locations for a business you frequent or a product you use gaining popularity organically provides a simple but powerful signal. These ground-floor observations can alert you to investment opportunities before Wall Street catches on.
Investor qualities: patience and rationality
While temperament and approach are important, Buffett and Lynch also emphasize other critical investor qualities.
Having the patience and discipline to hold quality investments long term is key. It may take years for the value of a great business to be realized in its stock price. Avoiding the temptation to make emotional, impulsive decisions is critical.
The ability to think rationally is also paramount. Investor psychology and biases can lead to poor judgment. Controlling fear, greed and other urges enables wise decision-making.
Advocates of simplicity
In the world of investing, there is no shortage of complexity. However, according to Buffett and Lynch, complexity is not required for success.
Expansive intellect, credentials and expertise can actually be hindrances. These tend to amplify confidence in quantitative analysis. But markets are fundamentally unpredictable in the short term.
Instead, temperament, common sense and basic research are an individual's keys to success. Thinking independently, remaining rational and focusing on the long term enables great investing.
Ultimately, if you stay disciplined, leverage your perspective and make rational decisions, investing intelligently is certainly within your reach. You may even become the next Buffett or Lynch.
