“Hey Vishal, have you read about how Albert Einstein lost so much money in the stock market?” asked my friend Ravi as we met for dinner over the weekend.
“Yes Ravi,” I said. “In fact, he lost most of his winnings from the 1921 Nobel Prize in the stock market crash of 1929.”
“Wow!” Ravi exclaimed. “And we are talking about one of the genius minds to have ever walked this planet.
“Right Ravi. And I’m sure you’ve also heard about Mr. Newton, who was wiped out while chasing the stock market bubble in 18th century England.”
“Yes Vishal, you only told me about Mr. Newton’s misdoings when we met a few months back.”
“Sometimes I fail to understand,” Ravi continued, “how men with such high levels of intelligence fail at such petty things as the stock market, even when you hear of investment stories about individuals who’ve made fortunes because of exceptional insights or sheer genius!”
“Because, my dear friend, the best rewards in investing don’t generally go to investors with the smartest brains but to those with the strongest stomachs.”
“Stomach? Are you serious?”
“Yes, Ravi. The famous American fund manager Peter Lynch said it wonderfully that the key organ for investing is the stomach, not the brain.”
“Yeah, but why the stomach? We aren’t talking about gastronomy here but investing!”
“Right, but haven’t you heard of this phrase – Do you have the stomach for….?”
“Yes, I have. But how does it relate to investing Vishal?”
“It does, Ravi. Most of sensible investing is about going against the crowd. Often, it also requires you to face constant criticism and ridicule. You also need to stay away from the noise to be able to think rationally. You may also have to bear being called a loner. In such times, you must have the stomach to keep playing the game without getting perturbed by what others are wanting and asking you to do. You may have the brain to know what’s right and not right for you. But it’s your stomach that leads you to act on your conviction.”
“That sounds too much of a task, Vishal. How does one go about building a strong stomach to deal with such situations? Like you learn to develop your brain, is there a process to develop your stomach in your sense of the word?”
“Oh yes, there are a few things you can do to build strength in your stomach to be able to invest well.”
“And what are those few things Vishal?”
“Well Ravi, the first thing is that you should invest with your own money. Understand the fundamentals of investing, and then use your own money to apply those fundamentals. Never borrow money to play the markets, for then you are setting yourself up for a disaster in case the market takes a hit and you are leveraged up. You see, many people who lose confidence and panic in a market downfall are those who either don’t know what they have been doing or have invested using borrowed money that they must repay.”
“Agreed, Vishal. I invest my own money. What next?”
“Think and act long term.”
“Well, this sounds good when your stocks are doing well. But when everyone’s losing money, how do you think and act long term?”
“True. It’s difficult to act sanely in those times. And that’s why I have always believed that you need a strong stomach than a sharp brain to do well in the stock market in the long run.”
“Please explain, Vishal!”
“Look at how Einstein and Newton lost so much money in stocks. They had super sharp brains, but they still lost a lot, right? Look at how the geniuses at LTCM fund, including a Nobel prize winner, got wiped out in the last 1990s. Look at how Mensa, the high IQ society, terribly underperformed the markets by averaging just 2.5% return during a 15-year period when the S&P 500 did 15.3%. These are all instances that tell you why big brains won’t get you far in stock market investing.”
“Good examples Vishal. I remember you also told me something that Mr. Buffett had said about high IQ?”
“Yes, Ravi. He said that if you are in the investment business and have an I.Q. of 150, sell 30 points to someone else. In fact, in the same breath, Mr. Buffett also said that one needs an emotional stability and inner peace about his investment decisions.”
“Right, emotional stability and inner peace…”
“Yes, and that’s what a strong stomach helps you with – emotional stability and the ability to maintain inner peace during the outer panic.”
“So what use is the brain when it comes to investing?”
“Oh yes, you need some level of intelligence to understand the investment principles and what could get you into trouble, and understand the importance of having a long-term perspective. So, the brain has an important role to play too. But as I’ve told you a few times in the past, our brain has several leakages that scientists call ‘biases’, which lead us to react emotionally, and which is not a good way to go about investing sensibly.”
“Yes Vishal, as I have experienced first-hand, a greedy response when everything seems bright in the stock market, and a fearful one during falling stock prices is not generally helpful.”
“You’re a smart investor, Ravi,” I said with a smile.
“Yes Vishal, and like you do, I have also started living with low expectations that has been of great help, both in investing and in life.”
“Great, Ravi. Living with low expectations helps us lead peaceful lives. But we must still expect the unexpected because it helps us deal better when the unexpected actually happens.”
“Why do you say so?”
“Well, look back at the history of the market. There’s always a bear market waiting behind a bull market. And there’s always a bull market waiting behind a bear market. That’s just the nature of the stock market. If you are not surprised when it happens, you know you have a strong stomach.”
“Always remember that when it comes to investing in the stock market, it is often going to be scary, and there will always be something to worry about. But if you have a strong stomach, which will happen if you invest your own money, invest for the long run, invest in high-quality businesses, and always expect the unexpected, you will most likely do well.”
“That’s a good statement to remember, Vishal.”
“Yes Ravi. I am sure you will.”
