Monday 23 October 2017

The IQ, EQ and AQ in Investing

To be successful in investing, it takes more than just having a high Intelligence Quotient (IQ). As Warren Buffett said, "Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ." Besides IQ, Emotional Quotient (EQ) and Adversity Quotient (AQ) also play important roles in determining the outcome of our investments.

Intelligence Quotient (IQ)

IQ is about the ability to rationalise our investments. It involves setting up a framework to determine asset allocation, risk management, stock selection, stock valuation, buying and selling rules, etc. If you are an active investor who picks stocks or unit trusts, IQ is at work most frequently in the last 3 activities. Nevertheless, being able to spot a good investment is important, but not sufficient, as we shall see in the section on EQ later. 

It is also not necessary for an investor to have high IQ to be successful. If an investor recognises his limitations in picking stocks, he could become a passive investor and buy a basket of market indices and still be able to reap good results. See All I Want Is To Invest Wisely for more info.

Emotional Quotient (EQ)

EQ is about the ability to control our emotions from running wild and interfering with our investment rationale. Examples are: not being influenced by peers or market rumours, not getting too excited when we spot a good investment and buy beyond our means or position limits, not chasing the stock as it goes above our target buy price for fear of missing out, not losing our nerves as the stock keeps on rising or falling, etc. Essentially, it is about making sure that we do not do something stupid that we might later regret had we thought through more comprehensively. If we have the IQ to spot a good investment but do not have the EQ to hold on to it until its full potential is realised, our competency as investors will be diminished. 

Personally, EQ is my weakest link. There have been countless examples where I get too excited, chase a stock or sell too early. I also have loss aversion bias, which means that I sell my winning stocks too early and hold on to my losing stocks. In addition, I have phobia about financial crises, having gone through both the Asian Financial Crisis and the Global Financial Crisis. EQ is the area I have to work on if I wish to improve my investment results.

Having said the above, the good news is that EQ can be managed to some extent using IQ. For example, by setting rules on stock valuation, position limits, target prices, etc. and following them strictly, emotions of fear and greed can be managed to some extent. See Have a Plan for more info.

Adversity Quotient (AQ)

AQ is about the ability to survive difficult times, such as at the depth of a market crash. Do you give up and sell out, or do you rationally look at the situation and identify potential silver linings among the dark clouds and act accordingly? In a way, AQ is related to EQ, but there are some differences with EQ. The emotions that I associate with EQ are greed and fear, while the emotion that I associate with AQ is despair. They are different emotions and some people can handle one emotion better than another. For me, I can handle actual losses (both realised and unrealised) much better than the fear of losses. A case in point is my Oil & Gas (O&G) portfolio. Although the unrealised losses are heavy, they have not seriously dented my confidence in managing them. I am still taking steps to turn them around.

Conclusion

To be a really good investor, you not only must have high IQ, but also high EQ and AQ. I am still trying to improve in these 3 areas.


2 comments:

  1. It is good that you explored the different emotions and understood your strengths and weakness, so you can steer yourself through the choppy seas and chart your investing journey ahead.

    Greed, I have experienced. Fear and despair not yet. Still new to the journey. How do you cope when things are going downhill, and appear to be depressed for seemingly forever?

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    1. When there's fear, I will review my portfolio to see if it needs trimming, such that I keep only those stocks which I have faith with.

      When there's despair, I will not look at my portfolio losses so that I won't do anything stupid. Occasionally, I will come back and see if there are any bargain stocks to be bought.

      Emotions are not easily handled. Experiencing them is very different from talking about them.

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