The difficult lessons investors have to educate themselves in
• It is no easy task getting your mind around at least some of the factors at play in the markets
There are many difficult things that investors have to educate themselves about in order to deal with them effectively. New things: Warren Buffett famously opined that when the car was invented, the sensible investment decision was not to buy shares in vehicle companies but to short horses; sometimes it is wise to pass on buying into major technological changes.
The motor vehicle industry worldwide has managed to produce a profit only one year in five. The consolidated profit and loss account for the world’s vehicle manufacturing business shows chasmic losses since the car was invented.
Experts: Pundits’ opinions come with an undeserved air of authority. The mere fact that they are being interviewed or written about gives them a measure of credibility. If they have important-sounding credentials, can articulate a point of view and look convincing enough, we tend to believe them.
Be careful about investing too much time listening to “experts” who face no consequences for being wrong. Remember that the media’s job is to entertain rather than provide sound financial advice.
Optimism: On balance, optimism is linked to financial success and is a good thing. Too much optimism, however, is a bad thing. It is no coincidence that extreme bull markets are called manias.
Manic optimism aside, there are deleterious effects of “everyday” optimism on thought processes (called optimism bias), which results in dangerous risk taking, poor analysis, frivolous spending and wealth destruction in tangential pursuits and poorly thought out stratagems.
Optimistic investors make a characteristic mistake — they act as if good times will last forever. The problem is that our perspective changes in reaction to the markets. Our moods shift as prices shift. Monday the markets are up and we are optimists. On Tuesday, they dive and we are pessimists. And there are always those waiting to take advantage of both.
Chaos: Your brain abhors disorder. You see faces in clouds and demons in bonfires. When you need something to be true, you will look for patterns; you connect the dots like the stars of a constellation. There are those who will tell you that is a dumb thing to do.
On the other hand, Chuck Palahniuk may be right when he says: “There are only patterns, patterns on top of patterns, patterns that affect other patterns. Patterns hidden by patterns. Patterns within patterns. If you watch close, history does nothing but repeat itself. What we call chaos is just patterns we haven’t recognised. What we call random is just patterns we can’t decipher.”
So, there are basically two options: to assume that you cannot possibly make any sense of it all, in which case why bother trying; or — if you think you have the talent to make the right choices and some luck — try to take advantage of the chaos. As difficult as that might be, it’s got to be the more exciting of the two.
Emotions: Economic statistics and security analysis are not the only things that go into a buy or sell decision. To quote Benjamin Graham: “How your investments behave is much less important than how you behave.” If you’re down a huge amount, you’re not thinking straight. If the markets do something that completely floors you, you’re a deer in the headlights. Understanding how our brains work — our limitations, endless mental short cuts and deeply ingrained biases — is one of the keys to successful investing.
The unexpected: There are those who will tell you that markets are driven by fundamentals, others who talk of beta and go in search for alpha. But history has taught us, again and again, that when it comes to finance, the unexpected should be expected.
No financial system in recorded history has operated without a crisis that decimated value. It’s not so much a question of “if”, as of “when”. The aim of all investors should be to ensure that their portfolios are positioned to profit regardless of the economic environment or the performance of particular markets. “The problem for most investors is that they’re not equipped to deal with a rise in volatility and declining markets,” says Seth Klarman.
Being wrong: If you are unable to admit being wrong — which happens when you don’t define what being wrong looks like — you will be perpetually anchored to your own ego and view of the world. Admitting you are wrong, fixing it and moving on is essential.
But don’t stop. Don’t ever stop. Moving on is different, you keep the accumulated “wealth” (skills, lessons, experience, money) and redirect it.
“We should always try to move on rather than quit,” says Nigel Davies. “Just change the balance rather than go in with major surgery. It means readjusting positions within shades of grey rather than opting for black or white.”
Reality: The truth is no-one really knows what a corporation is worth, but we agree on a price and pretend it makes sense. Very few people question how it all works behind the scenes. The amount of faith we all put into the markets, businesses, and institutions is nonsensical when you think about it. We all have a system. Some are terribly clever — in the sense of being developed by PhDs and running on supercomputers — but that doesn’t stop Amazon adding billions to its market cap and others shedding billions in the space of a few months. Do these businesses really change that much in such a short time? It seems unlikely.
Indifference: The market doesn’t care about you. There is a danger in ascribing intelligence to this thing, tempting as it may be to think that it’s you against it, that you’re in some mano a mano battle and need to outwit a formidable opponent. Whatever happens to you, the market will just continue to be what it is.
HISTORY HAS TAUGHT US, AGAIN AND AGAIN, THAT WHEN IT COMES TO FINANCE, THE UNEXPECTED SHOULD BE EXPECTED