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Temperament vs. Intelligence

Mike Earl, CFP®, CPWA®


“Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”

Warren Buffett

Buffett has said that “investing is simple, but not easy.” We often say the same thing about personal finance. The concepts are not terribly complex, but the implementation of good decision-making is not easy. If it was easy to spend less, save and invest more, and invest wisely, the average Boomer would have a lot more than $21,000 in retirement accounts.

Being wicked-smart doesn’t always translate to being a great investor. Buffett also says that temperament (defined as emotional responses to events) is more important than intelligence for investing – and we agree. When the US stock market tumbles 35% in just over a month, an investor with a million-dollar portfolio in all stocks saw $350,000 vanish in a hurry.

But did that $350,000 really evaporate, never to return? Not if the investor stays fully invested. Yet if that investor let his emotions turn into fear and pessimism, he may have sold his stocks into cash. At today’s interest rates, his cash pays him anywhere from 0.5% - 1.5% per year. With his portfolio in 100% cash, he is removing the risk of losing capital. He is also removing the opportunity of his portfolio to appreciate meaningfully from its current level. He has gone into preservation mode, seeking to protect his capital from further declines. I won’t mention inflation at length here, but suffice it to say that his capital is immediately losing ground to inflation.

On the other hand, consider an investor with a steadier, more optimistic temperament. For this investor, the 35% decline is just a temporary decline, not a permanent loss. She remains fully invested, even when it’s painful. And now she has already recovered a good bit of the decline. She is not yet back to even, but her portfolio value is likely similar to where it was in the spring or summer of 2019. In other words, she is currently set back to values last seen less than one year ago! Not so bad.

The folks with MBAs from prestigious business schools can be tempted to think they know more than the average investor. When you think you know more than the Average Joe, you might believe you are smarter than the market. And that can lead you to make market timing decisions, where an investor attempts to time exit and entry points into the global markets at various times – based on worldview or expectations about the future.

As the stock market had a waterfall decline in March, the news media and scientific experts were saturated with dire predictions of how “the worst is yet to come”. Being well-read on COVID-19 led some folks to have a myopic focus on dire predictions of millions dead and a global economy that might never truly recover. Consequently, there was a strong pull for investors to “do something” in response to rapidly declining stock prices.

For every 100 people who “saw this coming” and sold out of stocks earlier this year, how many of them got back into stocks at the market low on March 23rd? How many got back into stocks on April 1st or April 10th or April 20th? How many are back into stocks today? I would wager that a great majority of people that sold out of stocks sometime before or during the downturn have not yet bought back into stocks today.

While another leg down in the stock market is possible, it’s also possible that new all-time highs are set in the US stock market yet this year (or in 2021). It’s more important to admit that we can’t predict the future, while also maintaining an optimistic worldview about global economic progress over the long haul. Most of our clients are investing for long time horizons. Even today’s retirees expect to need their retirement nest egg to last for multiple decades.

When you admit that you don’t know how global events will play out in the short-term, you take a great step in setting yourself up for long-term investing success. By exiting the market timing trap, you can allow your brainpower to focus on much more important investing decisions:

  • asset allocation (how much in stocks vs. bonds?)
  • diversification (do I have all my eggs in one basket?)
  • tax efficiency (am I saving aggressively enough in tax-preferred accounts and tax-efficient funds?)
  • savings rate (am I saving and investing enough to provide for my family when I can’t or don’t want to work any longer?)
  • keeping costs low (what are the internal expenses of the investments I hold?)

A big part of our job as financial advisors is keeping our clients invested through the inevitable ups and downs of the stock market. We’re here to help.

Disclosures:
Because The Wealth Group, Austin B. Colby & Associates is independent of Raymond James, the expressed written opinions above are our own and not necessarily reflective of Raymond James’ opinions.

This commentary on this website reflects the personal opinions, viewpoints and analyses of the team members providing such comments, and should not be regarded as a description of advisory services provided by The Wealth Group or performance returns of any client of The Wealth Group.

The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. The Wealth Group manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.