The crowd becomes an unthinking mob at tops and bottoms. Being able to read the emotional state of the market, as well as keeping your own emotions in check, are hallmarks of great investors.
Trial lawyer: Good litigators are always skeptical, but not negative. Is that witness telling the truth? What is motivating him? Is the opposing counsel’s argument logical? Being able to answer these questions makes for a good lawyer – and a good investor.
All CEOs want you to buy their company’s stock; every analyst wants you to follow his equity calls; every fund manager wants to run your money. When it comes to investing, everyone is trying to separate you from your money. Good investing requires good judgment. Being able to recognize valuable intel versus the usual blather is a huge advantage.
Like a good litigator, you must question data, consider alternative explanations, argue against the obvious. You cannot blindly accept everything you hear as truth, nor can you reject everything out of hand. Being able to discern between information that is valuable and that which is not, is crucial.
Mathematician/statistician: Investing is filled with math: compound interest-rates, dividend yields, long-term gains, price-to-earnings ratio, risk-adjusted returns, percentage draw downs, annualized rate of returns.
Don’t worry if you suffer from math anxiety: If you can operate the simplest calculator — even the free one that came with your computer — you have the requisite math skills needed.
If you follow the professional literature there is a plethora of advanced mathematical formulas of dubious utility. Value-at-risk is a complex mathematical formula that was supposed to tell Wall Street banks how much risk they could safely assume. It failed to prevent them from blowing themselves up during the credit crisis. The Sharpe ratio measures the excess return — the “risk premium” — an investment strategy has. Even William Sharpe, its creator, has said it’s been misapplied by Wall Street’s wizards.
Investors can ignore these sorts of mathematical esoterics. But understanding basic math is key.
Accountant: When you buy a stock, you are buying an interest in a company’s future revenue and profit. How much you pay for that future cash flow determines whether you are over or under paying. That means understanding the basics of a company’s books is a key to recognizing value.
An understanding of basic accounting is essential to grasping the fundamental health of a company or business model. It is how you determine whether an existing company is profitable, or when a young firm might become profitable. But it also can help you determine when a formerly profitable company is heading down the wrong path.
You don’t have to be a forensic accountant. These are sleuths in green visors poring over pages and pages of quarterly filings and footnotes, looking for evidence of fraud or accounting shenanigans. Forensic accountants are the guys who discovered the frauds at Enron and Worldcom, and they warned about AIG and Lehman Brothers.
Amazingly, even after these frauds were revealed, many investors refused to believe them. Having a basic knowledge about accounting can help you understand and heed the work of forensic accountants.
You don’t need to have an MBA or doctorate in economics to be a good investor. Indeed, as the spectacular blow up at Long-Term Capital Management has taught us, these can be impediments to good investing.
Instead, you need to develop more general skills. Learn market history, understand crowd psychology, how to think critically, be able to do simple math and understand basic accounting. Do this, and you are on the path to becoming a much better investor.
Ritholtz is chief executive of FusionIQ, a quantitative research firm. He runs a finance blog, The Big Picture.