During this year’s Berkshire Hathaway annual meeting, Warren Buffett discussed the importance of his eventual successor as CEO having ‘a money mind’:
“People have to have a money mind. They can be very smart but make very unintelligent money decisions; their wiring works that way…
Though I was in attendance, the importance of this commentary didn’t register right away. The more I thought about it, however, the more I realised it’s a great mental model for evaluating your financial skill set, as well as those of others such as fund managers and financial advisors.
We all know otherwise well-educated people who make dumb money decisions. That person might even be you from time to time, and I’m certainly in that camp.
Indeed, in a moment I’ll share why even financially-savvy people may not always be in the right ‘money mind’ state.
Putting your mind under the microscope
So, what is a money mind and why should it matter to you?
A money mind should:
1. Understand opportunity costs
Put simply, opportunity costs measure the gains you’ve forgone to make another choice.
Let’s say you choose to attend one university over another. Since you can’t attend both simultaneously, your opportunity cost is what you would have benefited by attending the other school.
As investors, we face opportunity cost decisions all the time, whether we recognize them or not. Cash or shares? Bonds or property? Company XYZ or the FTSE 100?
A money mind will acknowledge his or her objectives and time horizon, and balance those with current market opportunities.
For an investor with a 30-year time horizon, for example, the potential opportunity cost of holding cash is rather high when considering that the stock market’s returns over rolling 30-year periods have been consistently positive.
2. Have high emotional intelligence
Warren Buffett also famously quipped that:
“Success in investing doesn’t correlate with I.Q… Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”
There are four critical aspects of emotional intelligence, according to Travis Bradberry and Jean Graves in their book Emotional Intelligence 2.0.
These four aspects are: Self-awareness, self-management, social awareness, and relationship management.
As investors of our money or someone else’s capital, we must be able to recognize our biases (self-awareness), be able to act at times against those biases (self-management), understand the emotions of other investors (social awareness), and balance our emotional state with theirs (relationship management).
These requirements are a tall order, especially when we’re facing outside stressors in our personal lives.
A few years ago, for instance, my wife and I bought a car immediately after moving to a new city and buying a new house – both major life events. By the time we walked into the car dealership, I had decision fatigue and didn’t spend enough time preparing for the purchase the way I normally would have. I ended up overpaying.
An ideal money mind would have Spock-like reason and be immune to outside stressors, though this is more science fiction than reality.
Instead, seeking a state of controlled emotion seems the best strategy for most. A money mind will more frequently strike the right balance.
3. Be able to think and act long-term
Rarely will you find a capital allocator or company executive who admits to being short-term focused, but the numbers tell a different story. Capital allocators such as fund managers frequently feel the pressure of monthly, quarterly, or yearly results. Portfolio turnover is much higher than it otherwise might be.
For an investor to truly think and act long-term, they must have the personal capacity, the right clients, and the right investment vehicle to do so.
If you manage money for someone demanding quarterly performance, for instance, you will have a hard time executing a long-term objective. This could be a reason why Buffett operates a corporation with steady insurance float to invest, rather than managing an open-ended mutual fund.
We individual investors have a tremendous advantage in our ability to be patient, since we have no outside capital ready to flee following a year of market underperformance. Sadly, few investors fully capitalize on this valuable advantage.
Money minds will seek out environments that will enable them to execute their objectives.
4. Judge investments on value and not on price
One of the bigger mistakes that investors make is buying things that look cheap based on price alone, without consideration to quality.
It’s an issue we often face as consumers. Let’s say you need a new coffee maker. Prices might range from £10 to £200 for a top-of-the-line brewer. The ‘cheap’ shopper will simply grab the one with the lowest price but runs the risk of coming back to buy another when it breaks due to poor assembly. The ‘value’ shopper, on the other hand, will find the highest quality coffee maker for what she needs at the best possible price.
At this year’s Berkshire meeting, both Buffett and his business partner Charlie Munger discussed how important the purchase of the See’s Candy confectionery chain was to their development as investors. Leading up to that investment, Buffett in particular was more attracted to so-called deep value shares. But he came to understand the attractiveness of buying a quality franchise at a good price and holding it patiently.
A money mind will recognize the folly of being penny-wise and pound foolish.
5. Be insatiably curious and contemplative
When I interview company executives, my last question is typically a request for book recommendations. More times than not, the manager will look at me like I have two heads.
“A book recommendation?” they’ll reply. This isn’t the response I want to hear.
While most analysts ask about quarterly trends or expected capital expenditures for the year, I’m more interested in finding out if the executive is a learner and thinker. Some CEOs and CFOs have told me they don’t have time to read, which could be a sign they can’t manage priorities or don’t consider reading a priority. Neither is a positive sign.
Every so often, an executive will light up upon my request and talk about a book they read on history, business, or science. This is more like it. Money minds will be fascinated by new ideas and figuring out ways to glean lessons applicable to their operations.
In a previous post, I suggested that assuming a normal distribution of capital allocation skill among company leaders, perhaps 3-5% can be considered exceptional. A true money mind is rare and isn’t always consistently so over time.
Nevertheless, whether we aim to wisely allocate our own capital or someone else’s, possessing a money mind is a goal worth pursuing.
What other money management skills might you add to my list above? Let us know in the comments below!
Todd Wenning, CFA is an equity analyst based in the United States. Opinions shared here are his own and not those of his employer. A full disclaimer can be found here. For compliance purposes, Todd cannot reply to comments below, though he welcomes any correspondence sent by email. You can read Todd’s expanding collection of dividend articles here on Monevator or check out his book, Keeping Your Dividend Edge.