What’s the key to being a great investor? As you may remember from Chapter 2, it’s temperament. The most successful investors consistently beat the market not because they have perfect timing or tons of money. They do it by identifying their natural inclinations (both good and bad) and using the methods, philosophies, and strategies that best match the way their brains are wired.
As Warren Buffett says, "Success in investing doesn't correlate with I.Q. ... what you need is the temperament to control the urges that get other people into trouble in investing."
How Are You Wired?
Likely one -- or several – of our investing strategies is best suited to your investing temperament. In your reading, one or two probably interested you more than the others. But how well do you know yourself? Do you know your tolerance for risk and loss? Have you pinpointed your investing time horizon? To what degree are you interested in digging into stock research? In other words, what color is your investing parachute?
We’ve designed the following short quiz to help you answer these questions and identify the investing strategies that are best for you.
1. You're at the store and on the shelf is an array of options for the product you need. Which are you most likely to toss into your shopping cart?
A. The brand you’ve purchased in the past, even though it lacks the bells and whistles of some of the others.
B. A pricier brand you’ve always wanted to try because it’s on sale for 20% off today.
C. A brand new product that promises revolutionary results.
D. A reasonably priced version that has not been FDA-approved, but has gotten favorable reviews from its customers.
2. You log onto your brokerage account. Which scenario sits are you happiest to see?
A. The market’s up a whopping 10%, but your stock gained just 1% during the run-up.
B. One of the companies you own missed hitting its earnings target and is down 30% as a result, giving you the opportunity to buy more shares at fire-sale prices.
C. Over the past six months a stock in your portfolio has traded anywhere from $10 to $80. It’s at the low end of that range right now, but you think it has the potential to double or even quadruple over time.
D. One of your stocks is up 15%, but there’s no obvious reason why, so you’ll have to do more research to find out.
3. Which activity are you most likely to choose at the theme park?
A. A spin on the Merry-Go-Round with your kids.
B. The newly revamped 3-D laser Zombie show.
C. The Nitro at Six Flags.
D. Forget the rides and head to the “Tastes of the World” food court.
4. How much information do you need to comfortably make buy, sell, or hold decisions?
A. You like to get regular company updates that are widely followed and analyzed by Wall Street, the media, and individual investors.
B. You prefer to check in on the business -- or its customers – first-hand either in person or via online forums.
C. You regularly consult SEC filings, trade journals, and industry forums and do all your own analysis.
D. You’re content with fairly regular coverage of the sector in which the company operates, even if news about your particular company can be spotty.
5. One of your companies is in the headlines today. Which event would not cause you to lose sleep tonight?
A. The company says it may have to temporarily suspend paying its dividend.
B. The launch of the company’s next product has been delayed for at least several months.
C. The Board of Directors is making noises about ousting the CEO in order to install an industry veteran.
D. The currency of the country in which your company operates has taken a haircut.
6. The business trajectory that most excites you is…
A. A stable, mature company with some room to grow via cost-cutting efforts, strategic acquisitions, and/or partnerships.
B. A newcomer that has not yet made a name for itself (and may not for many years) and has no heady expectations priced into the stock.
C. An innovative -- and often volatile -- company that challenges the status quo and has the potential to dominate (or create) a business niche.
D. A company that is ideally positioned to capitalize on fast-growing economies overseas.
7. What kind of volatility are you willing to endure on the road to wealth?
A. I’m not looking for massive growth -- I’m willing to settle for a couple of years of so-so returns just so I don’t lose a lot of money.
B. I’m willing to endure a few white-knuckle periods until my investment hits the bull’s eye.
C. I’ll hold on for dear life -- even while everyone else is bailing -- if I truly believe that the long-term payoff will be big.
D. I can stomach volatility that is beyond the company management’s control (e.g. currency fluctuations, political messes) if it means being in the right place at the right time.
What's Your Investing Temperament?
You've worked hard for your money and even if it means passing up headier potential returns, you’re most comfortable limiting your exposure to risk. Patience is your investing virtue. Like the great Warren Buffett, you have the temperament to wait for a quality company to go on sale.
Your stocks probably won’t wow anyone at a cocktail party -- after all, big-name, been-around-forever companies don’t typically make for riveting chit-chat. But when the confetti settles, it’s your time to shine. If your portfolio were a party guest, it’d be the designated driver: sober but reliable. It gets you where you need to go with no hairpin turns or squealing wheels.
This is the kind of investing we practice in our Inside Value and Income Investor services. The former focuses mainly on quality companies that have seen their share prices temporarily discounted. The latter seeks steady growth with investments that literally pay investors back -- dividend stocks.
More adventuresome value investors can expand their stock-hunting grounds by venturing into small-cap territory, the focus of our Hidden Gems service. If your answers yielded a mix of As and Bs, consider devoting a slice of your portfolio (perhaps 5% to 10%) to small-cap stocks.
Sound business practices (e.g., strong balance sheets, good management) are as important to you as any investor. But you’re willing to look for these things where few others dare to tread -- in small-cap territory.
While the rest of the world is fixating on the name-brand players, you’re prowling for their smaller, nimbler competition. At The Motley Fool, we call such companies Hidden Gems. Our Hidden Gems investing service specializes in uncovering these little-known businesses.
Because of their size, these companies fly well under Wall Street’s radar. The flip side is, of course, that they can often wildly fluctuate in a single trading day. But you have the stomach for some risk, particularly in the pursuit of bigger returns.
You could build a market-beating portfolio solely comprised of Hidden Gems (or any other type of investment, in fact). But it’s probably more reasonable to devote just a portion of your investible assets to the best-of-small breed of stocks -- anywhere from 10% to 40% of a portfolio depending on your comfort level.
If the thought of seeing an investment drop 25% in a single day gives you palpitations, then your may want to devote less of your portfolio to small company stocks. If “Bs” dominated your quiz results, then you may have the stomach to tolerate the volatility -- and the upside -- that comes with Hidden Gems territory.
Innovation gets your heart racing. When high-def, Bluetooth-enabled, surround-sound rocket boots hit stores, you’ll probably be the first person on your block to own a pair.
In investment terms, you seek companies that challenge the status quo -- those that take on an established business, reinvent it, and eventually usurp the original. Even better are those that create an entirely new market for something everyone didn’t even realize we couldn’t live without.
We call these companies Rule Breakers (apt, eh?). And in every way, these businesses defy the rules. Traditional valuation metrics like P/E ratios and discounted cash-flow calculations don’t fly in the land of Rule Breakers. The numbers often look wacky because the Street simply doesn’t have the tools to accurately assess these companies’ merits.
Fans of Rule Breakers are willing to put in a little unconventional elbow grease to research an investment’s merits because they know that when one hits, it hits big-time. Of course, when they burn, they burn bad. It’s the rule of Daedalus: You can’t keep flying higher and higher without eventually getting burned.
Rapid change is the M.O. in Rule Breaker territory. So as a shareholder you need to stay alert and be psychologically nimble enough to re-evaluate your investment thesis. In the world of Rule Breakers, flexibility is a must.
This may be the most exciting kind of investing there is. But you recognize the big-risk/big-reward connection. Your mistakes will cost you. But it’s a lot less painful if you spread the risk around like we do in our Rule Breaker service by investing in a handful of potential high-fliers.
You are a worldly Fool. In the pursuit of investment opportunities, you’re not afraid to tread into foreign territory -- literally. You recognize that the rate of growth of our economy versus others has changed. The U.S. will still grow, but there are countries where the growth opportunities are astronomical.
“International” is not an investing strategy per se. In our Global Gains newsletter service we seek investment opportunities overseas no matter what label they carry -- small cap, value, Rule Breaker, etc.
Global investing can be, well, foreign, so you must be comfortable with a little less clarity from the companies in this universe. Your comfort level with different accounting methods, shareholder laws, currency risks, and even "political risk" will determine how much of your portfolio to devote to international fare.
A combination of As, Bs, Cs, and Ds:
No, you’re not fickle. You simply seek a variety of opportunities to make your money grow. In your heart you know that investing in the stock market is the one true way to build inflation-beating wealth over the long-term. But sometimes your doubts overcome your determination to stay the course. You can be gun-shy, perhaps because of a few investing missteps in the past (burned by a hot tip, perhaps?). Or maybe the stock market’s recent contortions have left you questioning how much risk you really can stomach.
Your answers reveal a temperament that recognizes the true price of opportunity (taking on some amount of risk) and the real cost of waiting out the storm (missing the market’s brief yet inevitable uptick). Therefore you need clear parameters -- a crystal clear playbook like the one we use in our Stock Advisor service -- for picking stocks.
Your scenario-based temperament also shows a mindset that’s well-suited to allocating portions of your portfolio to the best investments from a variety of stock-picking approaches. That’s the focus of our Million Dollar Portfolio service -- a portfolio assembled using the best investment ideas from the universe of Fool analyst picks.
As to how much to put into which pot, the correct answer is the one that best lets you sleep at night and stick it out through thick and thin. Don’t fight your natural tendencies… instead play to your strengths and seek investments that sit well with you.
Finally, consider that the stock market’s recent gyrations may be influencing your answers. That’s understandable; even the best investors have been rattled, and may even be questioning their own core strategies. However, in volatility, there is opportunity. Not just in finding bargain stocks, but in taking the pulse of your own investing temperament in a real-world/real-money scenario.