This is the ability to stick with a process when things are not going well. When everyone else is claiming 40% gains it is hard to stick with a process that you know can only realistically deliver 10%.
If you bought $10,000 of $AMZN in 1999 you would now have $10,000,000. But at least 3 times in that period you would have experienced a 70% fall in value. Who has the temperament to live with that and stay the course. In reality not many of us, but those who can have a genuine advantage.
Some years ago Fidelity did a review of its most successful investors. Two types emerged as most successful. Those that were dead and those that had forgotten they had an account. Simply buying and holding had done far better as a category than any other major group. This does not of course mean that any one individual will not beat the pack.
Another story I have read, but cannot verify. Is one of the big US brokerage houses did a review of husband and wife portfolios from 1950 – 1980. These were families were both the husband and the wife held shares with the brokerage at the start of the period and the end. I understand the sample was quite small only circa 40 families. Invariably the wives had better returns. But many of them knew nothing about shares or investing. They had usually been given their holdings, often as a dowry, but because they had held through ups and downs they did better than their husbands. As you may guess the husbands had far fewer actual complete failures as a % of the holdings than the ladies did, but equally they had far fewer multi baggers. This may also have links into the theory that dividends produce the majority of returns.
People in general are too susceptible to anchoring bias and seeing their gain as being worth collecting (sell the shares) rather than valuing the company as it is today and seeing from here where can it get too. I personally set targets for each share I hold, I think you need to know when to sell. But I adjust these targets for new results/news and keep moving up those firma that are really growing.
This month (June 2018) Netflix has twice grown its market capitalisation in value in a single day more than the whole business was worth 6 years ago. Who could resist that gain and not want to take profits. Equally there have been days that the fall has been just as high? If you saw losses as big as your original investment can you stay the course?
Emotional Advantage may also help explain why Quantitative multi factor value approaches work so well. Because to operate such a strategy you have to be prepared to buy the disliked share a number of your emotional inputs have to be overridden thereby lessening their ability to detract from performance.
This factor may be one that is increasing in importance with the rise of Artificial Intelligence. Because AI has no emotion it follows its programming as such it does what it has been programmed to do without emotion. When the market is down it will do what works not follow the fad or fear of being sacked. As humans react with emotion, particularly in bad news situations, the ability to not react improperly becomes more valuable. As the level of hype increases and the amount of real news decreases they ability to not get spooked into action increases.
The existence of emotion is one very real facet played on by the financial services industry to get retail investors involved. The existence of demo accounts for most trading platforms does allow a user to understand the platform and how it works. It also means that as no real money and therefore pressure is involved so the user will potentially trade better than they will when real money is involved. This leads to overconfidence and too many people assuming they can successfully trade when in fact they cannot. In the US over 70% of retail traders make no money in the first year and 96% of forex traders lose money and end up closing the account.
Considering Emotional Intelligence also extends to being realistic about yourself. Charlie Munger has written about the importance of studying failure to enable you to spot and avoid mistakes. Peter Thiel talks about studying success so you can understand and apply those lessons. These are not two aspects of the same plan as both Munger and Thiel have publicly disagreed on the other’s approach. They are, I would suggest, two individuals playing to their individual emotional strengths. One of them is more positive, one more cynical and they have realised this and operate accordingly.
I am not personally a huge fan of meeting management. I think there is a truth in the numbers and 3 years of reading a Company Report shows whether management can explain what they are doing and then do it. I have been a Company Director and a huge part of the role is to sell the business and keep issues undercover. That is not the same as lying. I have dealt with a number of Government’s in a few countries, some of which I was definitely not paid enough to lie too. But equally it was certainly not my job to tell the whole truth. I am always well aware that the best con men are not successful because they tell the truth. That is not to say that I will not meet management or do not think others should. But I recognise I do not have the emotional/empathetic skills to really see behind the person and know whether they are telling me the truth. I doubt many really do.
Emotional Advantage is perhaps the hardest to bring to bear but may for many be the most useful. Further reading on this area might include Daniel Kahneman’s “Thinking Fast and Slow”.