Investing Takes True Grit

8 February 2016 | by Sean Stannard-Stockton, CFA®

“Grit is passionate perseverance of long-term goals, even in the face of frustration and failure.” – Philip Tetlock

Philip Tetlock’s book Superforecasting: The Art and Science of Prediction is a must read for serious investors. While many of the lessons to be learned relate to the mechanics of probability, the book also spends significant time examining the personality traits and behaviors that give rise to “superforcasters”.

In areas of life where chance plays only a small role, you can learn best practices, diligently implement them and over time expect to consistently perform well. But in areas like investing, where chance plays a large role in determining outcomes, Tetlock argues that participants need grit to survive and thrive.

Tetlock explains by contrasting learning to ride a bike with learning to make better forecasts:

“With bike riding, the “try, fail, analyze, adjust, and try again” cycle typically takes seconds. With forecasting, it can take months or years. Plus there is the bigger role of chance in forecasting. Cyclists who follow best cycling practices can usually expect excellent outcomes but forecasters should be more tentative. Following best practices improves their odds of winning but less reliably so than in games where chance plays smaller roles.”

Investing is an activity where even when you make correct forecasts about company fundamentals, successfully making money on your insight is far from certain. Likewise, you can make mistakes in your analysis and still end up with a winning investment.

This need for true grit helps explain why so many very smart people do poorly with investing. While intelligence is clearly an important trait of a great investor or forecaster, Tetlock argues that it is not nearly as important a trait as grit:

“The strongest predictor of rising into the ranks of superforecasters is perpetual beta, the degree to which one is committed to belief updating and self-improvement. It is roughly three times as powerful a predictor as its closest rival, intelligence. To paraphrase Thomas Edison, superforecasting appears to be roughly 75% perspiration, 25% inspiration… no matter how high one’s IQ, it is difficult to compensate for lack of dedication to the personal project of “growing one’s synapses”.

Market environments like the one we are in today, characterized by high volatility, a downward trend in stock prices, and high levels of uncertainty about economic conditions, can cause investors to lose faith in their process and make emotion-driven mistakes that end up undermining years of hard-won gains. The key to avoiding these mistakes isn’t a better understanding of economics, more complex spreadsheets or new trading software. It’s grit. It is the determination to continually question your assumptions, learn something new every day and keep at it no matter how tough it becomes.

During periods of rising stock markets, investors can get lulled into thinking that investing is easy. But the high rates of returns that stocks have offered to investors over the long-term come at a cost. In order to capture these long-term returns, investors are required to cope with periods of intense volatility and steep losses.

Since consistently timing the market is impossible, investors need to stay invested during these difficult periods in order to capture long-term returns. The evidence indicates that buying great businesses at a fair or better price offers significant potential to yield great long-term returns despite steep short term losses that almost always occur every few years.

This doesn’t mean you should ignore the market or just hold on and hope. It means continuing to gather information, updating your beliefs and taking action in your portfolio as needed or leaving it well enough alone if your analysis does not call for a change. Sticking to this process during tough markets and the inevitable periods of underperformance requires grit above all else.

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