People assume that investors who have done very well are smarter than others who have done less well. There is little evidence to support that theory.
Isaac Newton was a clever guy. Brilliant mathematician – invented calculus and made meaningful advances in pretty much anything else he studied. Competent physicist – mechanics, laws of motion, gravity, optics, dual nature of light. Master of the mint, and responsible for England’s, “Great recoining.” But as an investor – not so much.
Newton’s flaw was that he was human and during the South Sea Bubble of 1720 – 1721, he let ego, greed, regret over selling too soon, and fear of missing out, cause the loss of everything.
From February 1720 to May 1720 he made a profit of roughly three times capital on his rather small investment and sold his position. But from May to July it nearly tripled again and many of his friends had made a great fortune. Newton re-entered the market. This time with a large investment. Some of it borrowed.
Within a month it rose another 50%, but the month after it fell below his cost and by November he was broke. In today’s money something in the $5 million range disappeared.
Nicholas Nassim Taleb and Warren Buffet have both expressed the general idea that smart people make bigger mistakes. The evidence in Newton’s case is clear. The lesson is too.
Successful investing is about a great deal more than smart. You need to be smart enough to study a prospective purchase and you must learn when to sell based on arithmetic and financial fundamentals, but the bigger problems arise deeper in the brain.
The amygdala governs things like emotions and decision making. It does it without much reference to the higher brain. Logic is not important to it. When things are too good or very bad, the amygdala takes over and imposes its solutions. Unless the upper brain can ignore that sell, weak decisions occur.
The amygdala is a bit like a two-year-old. Impulse oriented, undisciplined, fearful, super-confident, impatient, lethargic and energetic. These are not the characteristics of the great investors.
We are all subject to this problem, so what is the defense?
Another person who knows you and your hopes, fears and expectations is useful. Someone who can talk you back in off the ledge when things get outside your zone of reason. Someone who can calm the amygdala and help you reconnect with the higher brain functions. Think of the relationship between Charlie Munger and Warren Buffett.
An advisor is useful here. Maybe this is their only significant value. Everyone needs a guide and everyone needs a trigger to access this conscience. One trigger that works is the idea that you should sell until you sleep. Fear, indecision, and greed all harm sleep. Take that shortage as a cue to talk to your confidante.
Ancient human nature can defeat the modern brain. Once you know that, you can minimize the problem.
Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario. In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.
Please be in touch if I can help you. firstname.lastname@example.org 866-285-7772