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How Investors Succeed: 3 Crucial Insights From Education Experts

By John Reeves - Nov 11, 2014 at 11:07AM

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Insights on how investors can improve their habits and processes.

Paul Tough's How Children Succeed: Grit, Curiosity, and the Hidden Power of Character is an outstanding book with many invaluable insights for parents and teachers. Tough's goal was to better understand how our experiences from childhood connect to outcomes in adulthood. Among the questions he hoped to answer was, "why do some children thrive while others lose their way?"

After consulting leading researchers and educators, Tough uncovered some very surprising answers. I was struck by how many of his findings are directly applicable to investing. Below are three discoveries from the book that might help you become a more successful investor:

1. Character is more important than intelligence when it comes to success.
Many people instinctively believe in what is known by experts as the cognitive hypothesis, according to Tough. This hypothesis holds that success is primarily dependent on intelligence, which must be developed as early as possible.

Educators, psychologists, and neuroscientists are now challenging this widely held view, however. Tough writes:

What matters most in a child's development, they say, is not how much information we can stuff into her brain in the first few years. What matters instead, is whether we are able to help her develop a very different set of qualities, a list that includes persistence, self-control, curiosity, conscientiousness, grit, and self-confidence. Economists refer to these as non-cognitive skills, psychologists call them personality traits, and the rest of us sometimes think of them as character.

This insight is precisely what was discovered from day-to-day experience by the KIPP (Knowledge Is Power Program) Charter Schools. These schools, which aim to provide students with everything they need to survive in college, found that:

The ones who persisted in college were not necessarily the ones who had excelled academically at KIPP. Instead, they seemed to be the ones who possessed certain other gifts, skills like optimism and resilience and social agility. They were students who were able to recover from bad grades and resolve to do better next time; who could bounce back from unhappy breakups or fights with their parents; who could persuade professors to give them extra help after class; who could resist the urge to go out to the movies and instead stay home and study.

In the world of investing, Warren Buffett makes a similar point when he says that, "Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ." Instead, Buffett believes that having the right temperament is critical to investing success. Those investors who possess patience, good judgment, and calm in the face of volatile markets are more likely to thrive than those without those qualities.

And the great thing about this insight is that those qualities that indicate a good character or temperament can be developed. Tough notes that IQ is very resistant to improvement after elementary school. On the other hand, "executive functions and the ability to handle stress and manage strong emotions can be improved, sometimes dramatically, well into adolescence and even adulthood."

2. Developing good habits and processes can lead to remarkable results.
Tough's discussion of the chess team at IS 318, a middle school in Brooklyn, is my favorite part of the book. Despite representing a school where more than 60% of the students are from low-income families, the chess team consistently beats wealthy kids from private schools and magnet schools. Remarkably, it's the best middle-school chess team in the country.

IS 318's outstanding chess teacher, Elizabeth Spiegel, insists on "teaching the habits that go along with thinking." She also emphasizes "that losing is something you do, not something you are." One of her more effective techniques requires each student to meet up with her for a post-mortem after every match, win or lose.

In those sessions, she critiques every move, and offers refreshingly candid commentary. On one occasion, she noted a player was doing well until he moved superfast, and then "did something really stupid." Through her dedication to helping her students think more effectively, she is able to turn them "move by painstaking move, into champions."

The lesson here for investors is obvious. Each of us can become better by slowing down and thinking about our processes and habits. Did you do a post-mortem on that stock you lost 40% on? Have you considered conducting a pre-mortem -- a technique that envisions what might go wrong before it happens -- on that growth stock that's on your watch list? Who provides you with honest criticism on your portfolio? Investors can definitely learn a lot from Spiegel, who points out that sound thinking requires that we understand our mistakes and become more aware of our thought processes.

3. Optimism is a critical component of success, and it can be learned.
Tough shows us that education experts have discovered that optimism is one of the essential qualities of those young adults who are able to remain in college and earn their degrees. And surprisingly, "optimism is a learnable skill, not an inborn trait," according to Martin Seligman, a professor of psychology at the University of Pennsylvania.

Seligman, who wrote the book Learned Optimism: How to Change Your Mind and Your Life, has found that pessimists "tend to react to negative events by explaining them as permanent, personal, and pervasive." For example, if they perform poorly on a test, they might just assume they're stupid, instead of re-evaluating their study habits. Optimists on the other hand, are better at finding explanations for bad events, which allows them to "pick themselves up and try again."

This is an invaluable insight for investors, who even under the best of circumstances, will always experience negative outcomes from time to time. Perhaps unsurprisingly, many of the most successful investors tend to be optimists. Josh Brown, a financial advisor and popular blogger, notes in a post titled Optimism as a Default Setting that if you count the perma bears on the Forbes 400 list or the pessimists who run Fortune 500 companies, "you will find none." He suggests that optimism as a "default setting" is the obvious approach for investors.

The insight from Seligman that we can learn how to become optimists is particularly helpful to me. Pessimism, I must confess, comes naturally to me, even though I recognize that it's not often a very helpful outlook for an investor or a parent. Perhaps the most important takeaway from How Children Succeed is that we can all change how we think. It may be too late for some of us to boost our IQs, but there's still time for all of us to develop more successful habits. I highly recommend this book for anyone who wants to learn more about this fascinating area. 

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