By Joshua Kennon
Whether your aim is to be a small town millionaire who collects $25,000 a month in dividends, interest income, and rents, an international real estate baron building hotels around the world, or financial genius with an impressive history with high returns, there are a handful of things that many great investors have in common. These traits fall under three broad categories: the right temperament, the ability to value assets, and an appropriate understanding of risk.
By developing them, you stand a chance at increasing the odds of reaching your financial goals, just as an athlete does by training in a gym.
1. To Be a Great Investor You Need the Right Temperament
If you strive to achieve good investment returns, you need to the right temperament. It is important that you realise temperament is different from knowledge, intelligence, wisdom, and discernment.
Patience: In the words of famed investor Warren Buffett, some things just take time; you can't get a baby in one month by getting nine women pregnant. There is a lot of truth in his statement.
The Ability and Willingness to Stick to a Plan While Ignoring the Crowd: If you have a firm grasp of financial history and know what works, such as buying assets for less than they are worth at attractive discounts to net present value then holding to collect dividends, interest income, and rents, you need to have the fortitude of character to remain steadfast. During the 1990's dot-com bubble, some of the best investors in the world who refused to give into the insane stock prices, thus appearing like "dinosaurs" and "old men", were sent letters asking if they were waiting for the second return of Elvis. Don't be swayed by public opinion.
The Emotional Capacity to Separate Market Fluctuations from Underlying Real Value: If you bought an apartment building in your hometown that generated $50,000 per year in passive income from rents and someone came up to you, offering to buy the place for $100,000, or 2x earnings, you'd likely ignore them or laugh in their face. If the same thing happened in the stock market, many people are apt to panic and accept the deal! It's very hard to get rich doing that.
2. To Be a Great Investor You Need the Ability to Value Assets and Businesses
If you've read my article If You Don't Know How to Value a Business, You Shouldn't Own Individual Stocks, you know it is vitally necessary to possess the ability to calculate the intrinsic value of an asset. It doesn't matter if that asset is a car wash, a government bond, a share of stock, a dry cleaning business in your hometown, or an international hotel conglomerate. Unless you can pull out a calculator and run the formulas yourself, you are always going to be operating at a significant disadvantage to the competition, much akin to a blind person trying to win a sharpshooting contest.
At first, the math involved can seem impossible, daunting, and down right confusing. However, if you continually remind yourself that all you are trying to do is answer one question: "How much should I pay for $1 of net present value earnings?", you'll be surprised how clear this simple mantra will keep your thought processes clear.
The answer to that question can mean rejecting 90 or 95 out of 100 investment opportunities, but remember this: it only takes a handful of good decisions to get rich or reach financial independence.
3. To Be a Great Investor You Need An Appropriate Understanding of Risks, Both Implicit and Explicit
Mark Twain once said that history doesn't repeat but it does rhyme. There is, perhaps, no better preparation for managing money and building your net worth than a firm grasp of financial history. There wasn't much fundamental difference between the real estate bubble, the dot-com craze, and the Dutch tulip bubble a few centuries prior. By arming yourself with an understanding of the human psychology that can influence the buying and selling decisions of individual men and women, you can improve your chances of avoiding stupid mistakes that could hurt your family's well-being.
Personally, I follow the mental model approach. A mental model is an idea, a concept, that is used like a tool to help you avoid making poor decisions. Mental models include things like the Horns Effect and Halo Effect, Veblen Goods, The Illusion of Choice, and Information Asymmetry. It may not be evident at first why these concepts are important to business and investing but studying them, adjusting for them, and putting them to work in your own endeavours can help grow your bank balance year after year.