When I started my career in investing, I thought the key to becoming a great investor was to study modern financial theory.
After all, that was how academics like Harry Markowitz of the University of Chicago and William Sharpe of Stanford won Nobel Memorial Prizes in economics.
Later, I decided to study the beliefs, habits and strategies of the world’s greatest investors.
I spent thousands of dollars with one of the world’s leading trading coaches, profiled in Jack Schwager’s classic, Market Wizards: Interviews With Top Traders.
I also studied technical analysis and alternative investments, and even completed a course on investing at Oxford University’s Saïd Business School.
Here’s the conclusion I came to…
You can master the mathematics of quantitative finance. You can learn to calculate the value of options with Nobel Prize-winning formulas. You can apply dozens of technical indicators.
But none of these skills will necessarily improve your investment returns.
So when people ask me what improved my investing the most, I give them a surprising answer.
I tell them it was my study of history and psychology.
There Is Nothing New Under the (Financial) Sun
Successful investing is all about understanding the big picture and rising above the daily noise of the market.
And understanding the big picture means understanding financial history.
As Mark Twain purportedly observed, “History doesn’t repeat itself, but it rhymes.”
Alas, history is not exactly Wall Street’s strong suit.
As Harvard economist John Kenneth Galbraith also observed, “The financial memory is very short.”
Studying financial history reminds you that markets move in cycles.
Some of those cycles are seasonal. “Sell in May and go away” means you will make most of your money in the six months between November 1 and April 30.
Some cycles are political. The presidential election cycle tells us that the third year of a presidential term is generally the strongest one. Presidents work hard to boost the market to improve their chances of reelection.
Some cycles are linked to the latest hot investment theme. Ten years ago, it was the “China miracle.” Five years ago, it was 3D printing. Recently, it was FAANG stocks and cryptocurrencies. Tomorrow, it may be artificial intelligence.
Understanding that each theme is just a fleeting fashion allows you to ride the trend both up… and down.
Profitable Investing: 100% Psychology
Trading coach Van Tharp argues that successful investing is 100% psychology.
Here’s why I agree with him…
You can subscribe to the best trading system in the world. But if you don’t follow its rules consistently, you won’t make any money.
The weakest link in any financial trader’s “system” is his psychology.
On Wall Street, there’s a rule of thumb that you should never invest with a portfolio manager who is going through a divorce.
Their unstable psychology will make them prone to many errors in judgment. Successful investing is more emotional stability than rocket science.
As Warren Buffett says, “If you have a 150 IQ, sell 30 points to someone else. You need to be smart, but not a genius.”
History + Psychology = Patience
The importance of history and psychology is perhaps best seen in the virtue of patience.
In practice, this means limiting the number of ideas you act on.
As global investor Jim Rogers put it…
One of the best rules anybody can learn about investing is to do nothing, absolutely nothing, unless there is something to do… I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up… I wait for a situation that is like the proverbial “shooting fish in a barrel.”
Buffett calls this “waiting for the fat pitch.” Buffett is doing just that today.
His Berkshire Hathaway is sitting on $144 billion in cash. And it is a drag on Berkshire’s returns today. Just like its $15 billion was in 1998 and its $43 billion was in 2004 – before Buffett made sweetheart deals to boost Berkshire’s long-term returns.
Buffett knows his history – and has the psychological discipline to be patient.
Like Rogers, Buffett is waiting for the fish in the barrel.
I suggest you do the same.
P.S. My favorite book on financial history is Edward Chancellor’s Devil Take the Hindmost: A History of Financial Speculation. It traces the origins of financial speculation back to ancient Rome and chronicles its revival in the modern world.
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