Self-discipline and investment success

03Aug06

The dirty little secret of the investment world is that there are a number of methods investors (and traders) can successfully use to achieve success. In this blog we have touched on a number of crucial factors, including a lengthy piece on “acquiring investment expertise,” necessary to become a seasoned investor.

It has been said that one does not need to be a genius to become a successful investor. Many (good) investment philosophies can be written on the back of a cocktail napkin. What may be more important is a wellspring of self-discipline to implement one’s chosen investment strategy.

Cordelia Fine in The Australian* discusses the results of a study documenting the effect various attributes had on predicted student achievement. The obvious result would be that IQ is the predominant factor in predicting academic success. That however was not the case.

What, they wanted to know, was the most important factor in school grades?

The psychologists discovered it was self-control, by a long shot. A child’s capacity for self-discipline was about twice as important as his or her IQ when it came to predicting academic success.

That is not to equate academic success with investment skill. There are some distinct differences, but self-discipline, or willpower is apparently a common theme. Fine had an interesting take on the question of limited willpower. The point being not to “…spread our inner resolve too thin…” The majority of investors they probably do not have, nor could they garner, the willpower to consistently and successfully implement any investment strategy, let alone a more complex one.

Long time readers of this site will expect a quote from Brett Steenbarger at TraderFeed when it comes to trader psychology. Dr. Brett breaks down the three elements of trading and how the affect performance.

  1. Strategy – aligning my trade with historical odds;
  2. Tactics – aligning my trade with volume flows for the day;
  3. Execution – using a reading of large trader behavior to obtain good prices on entry and exit and using position sizing and stops to ensure that I take equal, moderate risk on all trades.

By examining historical performance he can isolate where and when issues arise with his trading. Step 3, execution, is the likely trouble-spot, because that is the area where self-discipline comes into play. By monitoring one’s performance at this level a trader can hope to achieve “continuous learning.” That has to be good, right?

The financial media has a tendency to revisit certain stories again, and again. One of these is the ongoing saga whether Bill Miller at Legg Mason will keep his string of years outperforming the S&P 500 alive. By now we had found the entire story tiresome, but a recent article jibed with this question of self-discipline and investment performance.

Jonathan Burton at Marketwatch.com examines Miller’s relative underperformance this year and parses his statments on the topic. Two things struck us. First, Miller is willing to openly acknowledge his mistakes. Second, he is not going to deviate from his investment process just because it is experiencing a period of underperformance.

“We are long-term investors and not traders. Our contrarian approach often puts [us] at odds with the prevailing views in the market,” he wrote. “When our approach leads to underperformance, such as in the current market, there is increasing pressure to do something different.”

Miller, however, made it clear that he will resist that pressure.

“We have been doing this a long time and have been here before (way behind the market),” he told shareholders.

Things may, or may not, work out for Miller (and his shareholders) this year. In the long term scope of things one year’s performance is nearly irrelevant. What is important is the ability to generate an investment plan that if properly implemented has a better than average chance of beating the market. Self-discipline is the straw that stirs that drink.

*Hat tip to Arts & Letters Daily.

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