G6 EZ EE KLMNO SUNDAY, MAY 22, 2011

For the average person, that’s a substantial amount of money. But the average person cannot run an enterprise that’s as
global as Citigroup and have a near $2 trillion balance sheet.” — Analyst Pri de Silva, about the $42 million in compensation that Citigroup’s Vikram Pandit stands to collect

Your PhD in managing money

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
BARRY RITHOLTZ investment strategy has. Even William
Sharpe, its creator, has said it’s been
On Investing misapplied by Wall Street’s wizards.
Investors can ignore these sorts of

G
raduation season is upon us. From
the next generation of Warren
Buffett wannabes, I occasionally
hear questions such as “What should I
learn to become a great investor?”
Contrary to popular belief, investing
isn’t a traditional academic discipline.
Money management is hardly a typical
major. There are, of course, plenty of
“business administration” undergrads,
but their focus tends to be on running
companies rather than investing in them.
We churn out MBAs like made-in-
China widgets, yet few ever become
outstanding investors. And don’t even
ask about economists — the profession
that missed the housing boom and bust,
the Great Recession, the credit crisis and
the market collapse.
Great investors are savvy generalists. I
can think of five fields that are hugely
helpful to asset management. If you were
to study these disciplines, your
understanding of how markets work
would greatly improve. And you would
be a better investor.
How? You will generate better risk-
adjusted returns, meaning you will get
the most bang for the bucks you are
putting at risk. You will suffer less from
volatility — the stomach-churning ups
and downs in the markets that are one
part risk, one part opportunity. And you
will avoid the typical mistakes that most
investors make.
The five disciplines that can help:
Historian: Knowing what has happened
in the past (and how often) is an
enormous advantage when it comes to
investing. It informs you of the range of
possibilities, allows you to conceptualize
possible outcomes to various scenarios
and provides a framework for thinking
about market cycles.
Heading into the market bottom in
2003, some market historians warned
about a secular bear market. These are
the decade-plus long periods of huge
rallies and great collapses. Some warned
that investors should not be surprised if
after a decade, the markets were
essentially unchanged, which is exactly
what happened.
Think back to the market lows in
March 2009. After about a 20 percent
bounce off the bottom, quite a few
commentators expressed fears that the
markets had gone “too far, too fast.”
Market historians knew that the median
bounce after a drop of 50 percent or more
was 75 percent. With that information,
you might not have been scared away
from equities just before they gained 80
percent in value over 18 months.
Psychiatrist: Speaking of scared: Have
you ever sold anything in a panic — then
regretted it over the ensuing months?
What about the opposite — greedily
buying stocks that were screaming
higher because everyone else was?
Many investors fall prey to these
errors. Fear and greed are the most
enduring investor emotions. They lead to
destructive behaviors. Carl Richards, a
financial planner, sums it up thusly: “Buy
greed at tops; Sell fear at bottoms; repeat
until broke.”
Not understanding your own
psychology is the downfall of many an
investor. The best financial plan becomes
worthless if you are unprepared for the
emotional turmoil that accompanies the
ups and downs of markets.
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 vs. the
BIGSTOCK
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
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
underpaying. 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
blowup 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, know
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.

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