At the 2017 Berkshire Hathaway Annual Meeting, Charlie Munger, Warren Buffett’s partner, said: “A lot of other people are trying to be brilliant and we are just trying to stay rational. And it’s a big advantage.” It’s a simple, but crucial insight – a lot of the edge in investing can be traced to the ability to stay rational and execute your approach at moments of highest pressure and uncertainty. So what is the “mental game” in investing, and how do you make sure that yours helps your investing results?
“A-game” vs. “C-game”
Consider the technical skills of a good investor: assessing the quality of each company, modeling its financials, estimating the range of intrinsic value and then constructing a portfolio that thoughtfully balances risk and reward. Now imagine yourself under ideal conditions: you are calm, you have plenty of time to do your work, and there are no pressures on you, internal or external, to do anything irrational. That is your A-game. Working on improving any of these aspects – say, becoming a better business analyst, can allow you to make your A-game better over time.
Now think of situations where you might deviate from your A-game. Maybe you are in a rush and don’t do as much research on an important aspect of the business as you could have. Or perhaps you grow impatient waiting for bargains to appear and despite rationally knowing better, you start compromising on your investment criteria because of a desire to act. Or let’s say there are business pressures on you – to generate a certain level of returns in the short term or to avoid letting your clients know you own an unpopular investment that you rationally believe is best but your clients might disagree, and you act differently from the way you know you should. All of these are examples of your C-game. You have deviated from what your technical skill would have allowed you to do either for behavioral reasons or because of misalignment of incentives with your clients.
Most investors only work on their A-game
There are a number of well-defined ways to improve your A-game, such as:
- You can study more businesses and become better at business analysis.
- Experience might allow you to quickly focus on the key economic variables for each company, transforming a tedious financial modeling process to a streamlined one that is nonetheless just as effective.
- Observing many management teams over time can help you get better at picking out those who are both skilled and are aligned with your interests.
In the beginning the improvement is rapid, but assuming you apply yourself diligently over many years there comes a point of diminishing returns and progress slows down. It then becomes very difficult to take your A-game to a whole new level, although you should of course continue to gradually improve.
On the other hand, it’s far more difficult to know how to mitigate your C-game. Many investors are not even aware that they have one! The introspection and intellectual honesty required to catch yourself doing things that deviate from what your technical skills tell you is rational are not common. Let’s define your C-game as a combination of the magnitude of the deviation from your A-game as well as the frequency of such deviation. Decreasing either the magnitude of deviation or the frequency of deviating might lead to substantial improvement, even for an investor with a very strong A-game.
Which “game” matters more?
Consider two investors, the first with a slightly better A-game than the second. At first glance you would think that their results might be very similar. However, that might not be the case, and counterintuitively, it might even turn out that the investor with the weaker A-game is the better overall investor. Why? Because if that second investor is far better at minimizing her C-game, the significant difference in the two C-games may outweigh any difference in their A-games.
Not everyone can improve their C-game. Some just lack the temperament that allows them to remain calm and rational under pressure. Or perhaps they only like to dwell on their strengths and not their weaknesses. Such an investor would be permanently flawed, and it would be very hard for anyone (or even themselves!) to know that until they are tested under real-world conditions.
Book knowledge is relatively easy to come by in investing. So is quoting famous successful investors and adopting their investment approach. What is not always easy is the discipline and awareness to stick to your process when under tremendous pressure – which is exactly the time when doing so matters most. As Mike Tyson famously said, “Everyone has a plan until they get punched in the face.” I have come to believe that a combination of a good A-game and a good C-game will almost always beat a great A-game paired with a poor C-game.
How can you improve your C-game?
- Admit you have a C-game.
- Familiarize yourself with behavioral biases and how to guard against them.
- Make a list of situations where you feel the greatest pressure to act differently than you know you rationally should. Think through how you can avoid putting yourself in those situations. It is easier to avoid temptation than to resist it.
- Commit to sticking to a process. It’s fine (and even desirable) for your process to evolve over time. However, it should never change in the middle of considering any specific investment decision. When considering any investment decision, implement your current process. Then improve your process when not considering any specific investments.
- Consistently communicate as much as possible about how you are implementing your investment process to others whose opinion you respect (e.g. clients, mentor, peers). You are far less likely to deviate from your process if you know you are going to have to explain exactly what you did and why to someone you respect.
- Identify past “C-game” mistakes and do a post-mortem on what caused them. Then improve on 1-5 above to avoid making similar mistakes in the future.
The best investors are always learning and evolving. What I hope you get out of this article is that the path to improvement is not always through getting better at the technical aspects of investing. Yes, it’s hard to be a good investor without being at least proficient at them, but at some point it becomes hard to meaningfully improve in this area. On the other hand, becoming more aware of your C-game and working hard to minimize both its magnitude and its frequency can have a major positive impact on how well you do as an investor – a path to improvement that few are taking.