Behavior is More Important than Brilliance

Investing success accrues not so much to the brilliant as to the disciplined.  – William Bernstein

Stupid is as stupid does.  – Forest Gump

 

In investing, behavior is more important than brilliance, and it isn’t even close.

Consider the case of Sir Isaac Newton.  Newton was one of the most influential scientists ever and one of the most brilliant people of his era.

In 1720 the South Sea Company was the hot stock in London.  Newton purchased some shares and sold them later, doubling his money.

After Newton sold his shares the price of South Sea stock continued to rise.  Unable to stay on the sidelines while others were making money Newton jumped back into the market when the mania was near its peak.  He ended up losing 20,000 pounds, the equivalent of about $3 million in today’s money.

For the rest of his life Newton would not allow anyone say the words “South Sea” in his presence.  When asked how he had lost so much money, Newton replied:

I can calculate the motions of the heavenly bodies, but not the madness of people.

The problem wasn’t that Newton couldn’t predict the future; no one can.  The problem was that he thought he was brilliant enough to do so.  Newton should have focused on controlling his own behavior instead of predicting the behavior of others.  In the end his brilliance did not prevent him from losing a fortune.

Newton’s story demonstrates why, throughout most of history, being a successful investor has been so difficult.  Being brilliant isn’t enough, you also have to be disciplined, and it is rare for one person to possess this powerful combination of attributes.

Furthermore, when you combine brilliance and behavior things get complicated quickly.  After all, Newton was convinced that South Sea stock would continue to rise.  Believing he was right, you could argue he was being disciplined by buying more stock as the bubble continued to inflate.  As Newton discovered, when you mistakenly believe you are right being disciplined simply magnifies your losses.

Beating the Market is Difficult

Beating the market is not impossible, but it is incredibly difficult.  To pull it off you need to be both consistently brilliant and disciplined, and probably have some good luck as well.  And doing so gets more difficult as the time period gets longer.

If you can be consistently brilliant and disciplined incredible riches await, but don’t underestimate how difficult this is.  Wall Street is full of brilliant people working 80 hours a week trying to beat the market and only a small percentage of them pull it off.  To think you can compete with them as a part-time amateur is incredibly naive.

When famed investor Michael Steinhardt was asked what the single most important thing an amateur investor could learn from him was, his arrogant but valuable reply was, “That I’m their competition.”

Separating Behavior from Brilliance

I figured out a long time ago that I can’t compete with the professionals on brilliance.  I don’t have either the time or the talent.  But I might have a chance to compete on behavior.  After all, we are all human and, as Isaac Newton demonstrated, even the most brilliant among us can’t escape the foibles of human nature.

So is there a way for me to invest focusing only on behavior while ignoring brilliance?

As I wrote recently, Vanguard founder Jack Bogle, who died on January 16, 2019, pioneered index funds.  An index fund is a type of mutual fund that simply seeks to match the performance of a stock index like the S&P 500 by buying all the stocks in the index, rather than trying to beat the market.  Doing this allows index funds to keep the costs of investing low.  This strategy has been very successful, as well-run index funds have beat the vast majority of actively-managed funds over time.

There are many reasons to love index funds but I think the most important is that index funds, for the first time in history, allow us to separate behavior from brilliance in investing.  By investing in index funds you surrender the quest to be brilliant.  This requires a dose of humility and isn’t easy for most of us.

The compensation for this humility is that it frees you to focus totally on your behavior.  Giving up the quest to be right allows you to put all your attention on being disciplined.

Discipline in Action

What behavior will the successful investor need to master?  The answer is both more simple than you will believe and more difficult than you can imagine – doing nothing!

It turns out that when it comes to investing, discipline in action consists mostly of inaction.

As Bogle stated:

While the interests of Wall Street’s businesses are well served by the aphorism, “Don’t just stand there – do something!” the interests of Main Street’s investors are well served by an approach that is its diametrical opposite: “Don’t do something – just stand there!” 

Morgan Housel adds:

“Don’t do anything,” are the most powerful words in finance.  But they are both hard for individuals to accept and hard for professionals to charge a fee for.  So, we fiddle.  Far too much.

Of course, doing nothing assumes you have already set up a system of regularly investing in appropriate index funds.  Once this is done your major task, apart from adjusting your level of risk in response to changing circumstances and increasing the amount you invest as you make more, is disciplining yourself to do nothing.

Doing nothing will be difficult both when things are going well (some people will be making more money than you) and when things are going poorly (doing nothing in a crisis goes against human nature).  But in each case doing nothing is the correct move.

Consider the 2007-09 bear market.  The S&P 500 lost over 50% of its value between October 9, 2007 and March 5, 2009.  And yet the value of my personal account was worth over double in March of 2010 than it was at the low point in March of 2009, and by March of 2011 it was worth well over triple its March 2009 lows.  How did I achieve such incredible results?

You guessed it.  By doing nothing.  I simply continued investing a regular amount into several index funds during the crisis and my discipline paid off handsomely during the subsequent recovery.

Advanced Discipline

Once you master the difficult task of doing nothing you can graduate to more advanced behaviors.  I discuss several of these in an article titled 5 Simple Ways to Make Money Being Fearful When Others are Greedy and Greedy When Others are Fearful.  These methods include:

• Rebalancing
• Overbalancing
• Tilting to value, and
• Betting big during a crisis

In another article, The Progress Principle and Investing, I describe how even a moderate amount of courage during market corrections can pay off big in the long run.

But the big idea, and the behavior you most need to concentrate on, is simply doing nothing.  If you start off with a sound plan this alone will get you where you need to be.

Stay the Course

Let’s close with some more sage advice from Bogle, the father of index funds:

No matter what happens, stick to your program.  I’ve said “stay the course” a thousand times, and I mean it every time.  It is the most important single piece of investment wisdom I can give you. 

Setting up a system of regularly investing in index funds and then disciplining yourself to do nothing is the key to building wealth.  Simply stay the course.  Forget about being brilliant and concentrate on your behavior.  Your only job is to be better at doing nothing than everyone else.  It’s a tough job, but someone has to do it.