There are many ways to address the idea of “investment style.” Growth / Value, Active / Passive, Small Cap / Large Cap and many more. Perhaps we should look to see if these are really styles or whether these are the descriptors that come from something deeper.
Perhaps as deep as how our brain works.
We know our brains have an ancient part and a more modern part. The ancient brain has served us well for thousands of years. It is aware of danger and it prompts us to act when danger is discovered. The fight or flight response is a familiar manifestation.
The modern brain includes the Neo-Cortex which is the largest part of the cerebral cortex. It filters the information coming from the ancient brain so that we may act more appropriately.
That filtering is the problem for most investors.
Susan Cain in her book Quiet: The Power of Introverts in a World That Can’t Stop Talking, points out that the spectrum of behaviour from complete introvert to complete extrovert is known by how much the neo-cortex filters the ancient brain signals. Extroverts pay less attention to danger signals.
The neo-cortex seeks excitement and so extroverts tend to gamble and undervalue the risk aspect. They act more quickly and they get a bigger kick from winning. Does that sound like the people in power prior to the melt-down in 2008? Cain thinks it does.
Extroversion affects your personal investing style. Possibly profoundly.
Extroverts focus on the possible rewards rather than the possible danger. Their results tend to be spectacular and on both sides of zero.
Cautious introverts tend to miss some opportunities.
Neither approach is ideal, so what is the defence?
There are three steps:
- Know your extroversion dimension
- Be patient and highly disciplined. Use a set of guiding principles, even rules, to both monitor and condition investment behaviour. You will know the rules are helping if you are a little uncomfortable with them. If they have been created well, that discomfort will turn out to be unfounded.
- Have a guide who can call you out on decisions that are not rationally founded. Warren Buffett relies on Charlie Munger to be his conscience. Not everyone can have a sounding board this skilled, but they can have someone, perhaps an advisor, who knows their tendencies and can help curb them. A review of any portfolio manager will find a few positions that reflect the inner self. The conscience has the task of “dialing out the Barryisms.”
Market theory talks about efficient markets and informed, rational investors. Neither exist. Investors are a stew of emotions that make decisions based on incomplete information. Many decisions are little more than emotionally founded guesses. On the other side, the market is the amalgam of all these emotional decisions. Hardly the basis for efficiency.
There are few of us who can be fully rational around money. You will need an algorithm or a conscience to come close.
Don Shaughnessy is a retired partner in an international public accounting firm and is now with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.