The #1 Characteristic of a Great Investor: Guts

With both the housing market and the stock markets very volatile, I’m reminded that it is in this kind of environment when truly great investors show their true colors.

People tell me the following all the time:

“If condo prices drop from $500,000 to $400,000, I’ll be getting in. It’ll be a bargain.”

Or

“Condo prices in Miami won’t drop 50% because everyone will be buying.”

Only they are both wrong.

People want to buy an asset class as it goes up. It is human nature. You feel like you can’t go wrong. But as an asset class declines (whether it it houses, art, stocks, bonds) people get fearful and won’t buy. They also believe, as it declines, that it could decline further so why buy now?

Everytime someone tells me that they’re going to buy real estate on the cheap when it really hits bottom I ask them: Did you buy Yahoo at $8 a share a few years ago?

I thought not.

Hardly anyone did. If you did, you made quite a bit of money (as it went from $8 up to $40 and has now dropped back down to around $20.)

Same for Cisco (dropped down to around $10 a share), Intel (around $11), Etrade (down to around $2.50 and as high as $25) and on and on and on.

Few investors bought even though these companies’ fundamentals remained intact. It was too scary. The dot-com mania had busted. It was 2002-2003. Tech was dead. And the stocks kept selling off.

Only- tech wasn’t really dead.

To be a great investor, you must buy when everyone else is running for the exits. In order to do that, you have to have guts. Because when everyone is running for the exits, it means fear rules.

Famed investor Bill Miller of the Legg Mason Value Fund recently talked about what made a great investor with Money Magazine. He loves it when the market sells off:

Question: I have a theory that great investors are not unemotional but inversely emotional: worried when the market is making people happy and feeling good when everyone else is worried. Do you see that in yourself?

A. Definitely. I’m always much happier when stocks are trading at their 52-week lows.

It’s simple: Stock prices change more rapidly than business value. And rising stock prices mean lower future rates of return, while falling prices mean higher returns.

It would seem easy, with stocks, to buy as a company becomes cheaper. Only it’s not. It’s the most difficult skill to master because instinctively, you feel like you should sell (as a stock falls or the markets fall.) Miller explained it this way:

A. Most people are not wired to sell what’s going up and buy what’s going down. It hurts. But your profit is the difference between your average purchase price and your average selling price.

Bernard Baruch [a great investor in the 1920s] said nobody buys at the bottom and sells at the top except liars. Your stock will go down after you buy it, and it will go up after you sell it.

Being willing to lower your average cost [by buying more when a stock drops] is a great strategy. But it’s difficult.

Do you have the guts to be a great investor? Do you buy your favorite companies in the face of carnage on Wall Street? When everyone else is saying, “I’m out of this company” or when there is “panic” on the Street?

If you can master the skill of buying as the asset class sells off, you will be become a great investor.

In 2002, gold hit a 20 year low of $230 an ounce. It now is trading around $700. Who had the guts to buy it in 2002?

If they did, they are rich. And among the great investors.

It is a skill you can learn. Master it. Find your guts.