Inside Investor Manifesto, William Bernstein reveals four skills every investor needs to be successful:
First, they need to be interested in the process. It’s no different than carpentry, gardening, or parenting. If money management isn’t enjoyable, a terrible job will inevitably result, and unfortunately most people enjoy finances as much as they enjoy root canals.
Second, investors need more than just a little math prowess, far beyond simple arithmetic and algebra, and even beyond the ability to manipulate a spreadsheet. Mastering the basics of investment theory requires an understanding of the laws of probability and a sufficient knowledge of statistics. Unfortunately, as a financial columnist explained to me over a decade ago, fractions are a tough sell for 90% of the population.
Third, investors need a solid grasp of financial history, from the South Sea Bubble to the Great Depression. Unfortunately, this is something even professionals have real trouble with.
Even if investors have all three of these skills, it will all be for naught if they don’t have a fourth: the emotional discipline required to faithfully execute their planned strategy, come hell, high water, or the apparent end of capitalism as we know it. “Stay the course”: It sounds so easy when said at high tide. Unfortunately, that is not the case when the water recedes.
I want to spend some time on the historical component because I think it is very important.
As a young analyst in the investment industry, I quickly learned that my lack of experience made it difficult for me to keep up with many of my meetings with more experienced investors.
I needed to level up because it takes time to gain market wisdom and experience. You have to go through some cycles and you cannot speed up the process.
So I did the next best thing and started reading everything I could get my hands on to better grasp the history of the financial markets.
I read Frederick Lewis Allen, John Brooks, Charles Kindleberger, Charles McKay, George Goodman, Peter Bernstein, Maggie Mahar, Bethany McLean, Edward Chancellor, Jeremy Siegel, John Kenneth Galbraith, Fred Schwed, Charles McKay, Roger Lowenstein, and more.
The more I learned, the more I realized how much I didn’t know.
Here are some ways studying market history can help you become a better investor:
It gives you perspective on the extremes. Market movements always feel unprecedented right now.
And of course, every market environment is different. More data. We learn from history. New technologies and research tools. But the emotional pendulum always swings from one side to the other between fear and greed, risk and reward, panic and euphoria.
As Jesse Livermore once said, “Another lesson I learned early on is that there is nothing new on Wall Street. It can’t be because speculation is too old. Whatever happens in the stock market today, it has happened before and will happen again.”
Markets may always be higher or lower than you think, but nothing lasts forever.
It teaches you about cycles. Howard Marks once wrote: “Nothing in the investing world is as reliable as cycles. Fundamentals, psychology, prices and returns will rise and fall, presenting opportunities to make mistakes or profit from the mistakes of others. These are given.”
The difficult thing about loops is that they don’t run on a specific schedule. Some eruptions last longer than others. Some accidents are more painful than others.
It helps build humility. Studying market history helps you understand the difficulty of predicting the future.
The pundit graveyard is now filled with brilliant investors, economists and fund managers who are blinded by certainty.
History teaches you to avoid overconfidence.
It doesn’t tell you everything. Market history can help you establish a foundation, set expectations, and create probabilities for a variety of potential outcomes.
But it can’t help you predict the future.
Every market crash in history seems like an obvious buying opportunity because you know when the chart is turning. No one knows this in real time.
Also, history is emotionless. Backtesting is not emotional. Not people. Then you can’t backtest how you felt.
As Fred Schwed writes in his classic book: Where are the Customer Yachts?:
Like all of life’s rich emotional experiences, the taste of losing significant money cannot be conveyed through literature. You can’t explain to an inexperienced girl what it’s really like to be a wife and mother. There are some things that cannot be adequately explained to a virgin by words or pictures. Any explanation I can offer here cannot even approximate what it feels like to lose a literal pile of money.
Some things you have to experience for yourself.
For this reason my new book It is heavy on market history and data, but also spends a lot of time focusing on investor behavior and the psychology of markets. One without the other is useless.
It doesn’t matter how smart you are, how hard you work, or how data-driven you are about the markets. If you don’t have the right temperament to control your emotions when things get out of control, you won’t be successful in the markets.
And they will get out of control because human nature is one and unchangeable.
Michael and I talk about the history of financial markets and much more in this week’s Animal Spirits video:
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Further Reading:
The Bull Market of All Time
Now here’s what I’ve been reading lately:
Books:
My podcast book tour:
