The Little Book of Behavioral Investing: How not to be your own worst enemy (Little Books, Big Profits (UK))

by James Montier

Simple: It is far better to focus on what really matters, rather than succumbing to the siren call of Wall Street’s many noise peddlers.

Jean-Marie Eveillard of First Eagle affirms my contention by saying, “It’s very common to drown in the details or be attracted to complexity, but what’s most important to me is to know what three, four, or five major characteristics of the business really matter. I see my job primarily as asking the right questions and focusing the analysis in order to make a decision.”

essentially focus upon three elements: 1. Valuation: Is this stock seriously undervalued? 2. Balance sheets: Is this stock going bust? 3. Capital discipline: What is the management doing with the cash I’m giving them?

Investors faced with chronic uncertainty will turn to any vaguely plausible explanation and cling to it.

This behavioral pitfall of looking for confirming rather than disconfirming evidence is in direct violation of the principles outlined by Karl Popper, the philosopher of science.

He argued that the only way to test a hypothesis was to look for all the information that disagreed with it—a process known as falsification.

Berkowitz goes further and even provides a list of ways in which: “Companies die and how they’re killed . . . Here are the ways you implode: you don ’t generate cash, you burn cash, you’re over-leveraged, you play Russian Roulette, you have idiots for management, you have a bad board, you ‘de-worsify,’ you buy your stock too high, you lie with GAAP accounting.”

As Keynes said “When the facts change I change my mind, what do you do sir?”

I suspect that something similar happens in finance; investors get caught up in all the details and the noise, and forget to keep an eye on the big picture.

As Keynes said, “The market may remain irrational, longer than you can remain solvent. ”

There can be few fields of human endeavor in which history counts for so little as in the world of finance.

Self-attribution bias is our habit of attributing good outcomes to our skill as investors, while blaming bad outcomes on something or somebody else.

Sadly, few of us are as introspective as Einhorn. So to combat the pervasive problem of self-attribution we really need to keep a written record of the decisions we take and the reasons behind those decisions—an investment diary, if you will. Keeping

This study demonstrates why a real-time investment diary can be a very real benefit to investors because it helps to hold us true to our thoughts at the actual point in time, rather than our reassessed version of events after we know the outcomes. An investment diary is a simple but very effective method of learning from mistakes, and should form a central part of your approach to investment.

Part of the problem for investors is that they expect investing to be exciting—largely thanks to the bubblevision. However, as Paul Samuelson once opined, “Investing should be dull. It shouldn’t be exciting. Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas, although it is not easy to get rich in Las Vegas, at Churchill Downs, or at the local Merrill Lynch office. ”

“Never underestimate the value of doing nothing.”

Well, the evidence casts serious doubt on people’s ability to maintain their independence in the face of pressure.

Let me emphasize that it does not take genius to be a successful value analyst, what it needs is, first, reasonably good intelligence; second, sound principles of operation; and third, and most important, firmness of character.”

“The time to reflect on your investing methods is when you are most successful, not when you are making the most mistakes, ” or indeed Ben Graham’s exultation, “The value approach is inherently sound . . . devote yourself to that principle. Stick to it, and don ’t be led astray.”

So think carefully about the way you invest. Which of these errors have you committed most regularly? What might you be able to do to prevent yourself from stumbling down this path again? Thinking about these issues is the first step in overcoming your own worst enemy when it comes to investment—yourself!