More on this book
Community
Kindle Notes & Highlights
Read between
June 15 - June 24, 2018
However, from an investment perspective we may well be best served by using our C-system.
Perfect planning and preparation prevent piss poor performance. That is to say, we should do our investment research when we are in a cold, rational state—and when nothing much is happening in the markets—and then pre-commit to following our own analysis and prepared action steps.
The evidence above suggests that fear causes people to ignore bargains when they are available in the market, especially if they have previously suffered a loss. The longer they find themselves in this position, the worse their decision- making appears to become.
The “battle plan for reinvestment” is a schedule of pre -commitments that acknowledges both the empathy gap we will likely encounter and also helps remove the fear- induced terminal paralysis that we are likely to be suffering.
“One of our strategies for maintaining rational thinking at all times is to attempt to avoid the extreme stresses that lead to poor decision-making. We have often described our techniques for accomplishing this: willingness to hold cash in the absence of compelling investment opportunity, a strong sell discipline, significant hedging activity, and avoidance of recourse leverage, among others.”
Similarly, some 70 percent of analysts think they are better than their peers at forecasting earnings—yet, the very same analysts had 91 percent of their recommendations as either buys or holds in February 2008.
Psychologists have often documented a “self-serving bias ” whereby people are prone to act in ways that are supportive of their own interests. But, as Warren Buffett warns, “Never ask a barber if you need a haircut.”
For many years I had a sign next to my desk that said “Don’t question authority. They don ’t know the answer either!” This rather sums up my general disregard for authority. However, not many seem to share my distaste.
As if this weren’t bad enough, Terry and Brad also examined the performance of a group of accounts where you need your spouse’s permission to trade. Those men who needed their wives ’ permission to trade outperformed the single guys. Unfortunately, those women who needed their husband’s permission to trade underperformed the single women. So not only are men bad traders, they are a bad influence as well.
So if we can’t outsmart everyone else, how on earth can we invest? The good news is that we don’t need to outsmart everyone else. We need to stick to our investment discipline, ignore the actions of others, and stop listening to the so-called experts.
Analysts also have an embarrassing track record when it comes to target prices. As Ben Graham said, “Forecasting security prices is not properly a part of security analysis, ” but that doesn’t stop the analysts from coming up with daft guesses as to the future price of a stock. On average these targets are about 25 percent higher than the current price. However, they are worthless as forecasts. For instance, in 2000 the average target price of stocks was some 37 percent above the market price at the start of the year. The actual outcome was that they were up 16 percent. In 2008, the analysts
...more
It is far better to focus on what really matters, rather than succumbing to the siren call of Wall Street’s many noise peddlers. We would be far better off analyzing the five things we really need to know about an investment, rather than trying to know absolutely everything about everything concerned with the investment.
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?
For 84 percent of the time, it was possible to predict whether people believed the evidence was sufficient to subpoena Donald Rumsfeld based on just three things: 1. The extent to which they liked Republicans. 2. The extent to which they liked the U.S. military. 3. The extent to which they liked human rights groups like Amnesty International.
So, what can we do to defend our finances against this insidious tendency to look for the information that agrees with us? The obvious answer is that we need to learn to look for evidence that would prove our own analysis wrong.
“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?”
OF ALL THE DANGERS THAT INVESTORS FACE, perhaps none is more seductive than the siren song of stories. Stories essentially govern the way we think. We will abandon evidence in favour of a good story. Taleb calls this tendency to be suckered by stories the narrative fallacy. As he writes in The Black Swan, “The fallacy is associated with our vulnerability to over-interpretation and our predilection for compact stories over raw truths. It severely distorts our mental representation of the world.”
As Joel Greenblatt has observed, one of the reasons people shy away from value investing is that the stocks you consider have poor stories. As he puts it “The companies that show up on the screens can be scary and not doing so well, so people find them difficult to buy.” Support for this view comes from researchers43 who have explored the characteristics and performance of the most “Admired” and “Despised” stocks from Fortune magazine’s annual survey.
Bubbles and their bursts aren’t black swans. They are “predictable surprises.”46 This may sound like an oxymoron, but it isn’t.
If markets seem too good to be true, they probably are.
Self-attribution bias is our habit of attributing good outcomes to our skill as investors, while blaming bad outcomes on something or somebody else.
Keeping an investment diary may sound daft, but George Soros did exactly that. In his Alchemy of Finance he writes “I kept a diary in which I recorded the thoughts that went into my investment decisions on a real-time basis. . . . The experiment was a roaring success in financial terms—my fund never did better. It also produced a surprising result: I came out of the experiment with quite different expectations about the future.”
One final aspect of the bias to action is especially noteworthy—the urge to act tends to intensify after a loss—a period of poor performance, in portfolio terms. Psychologists53 have asked people to consider something like the following scenario.
The antithesis of this action bias is, of course, patience. Patience is a weapon you can use to protect yourself from becoming an ADHD investor. It is required because the curse of the value investor is to be too early—both in terms of buying (known affectionately as premature accumulation) and in terms of selling. Unfortunately, in the short term being early is indistinguishable from being wrong.
“Holding cash is uncomfortable, but not as uncomfortable as doing something stupid.”
“All men’s miseries derive from not being able to sit in a quiet room alone.”
“The hardest thing over the years has been having the courage to go against the dominant wisdom of the time, to have a view that is at variance with the present consensus and bet that view.”
“You can’t be a good value investor without being an independent thinker—you’re seeing valuations that the market is not appreciating. But it’s critical that you understand why the market isn’t seeing the value.”
Finally, you must have the perseverance and grit to stick to your principles. As Ben Graham noted, “If you believe that the value approach is inherently sound then devote yourself to that principle. Stick to it, and don ’t be led astray by Wall Street’s fashions, illusions and its constant chase after the fast dollar. 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.”
On average, golfers make their birdie putts two to three percentage points less often than they make comparable par putts.
The best-performing funds were those with the highest percentage of losses realized (i.e., the least loss averse). The best-performing funds are less than 1.2 times more likely to sell a winning position than a losing position. The worst-performing funds had the lowest percentage of realized losses. In fact, the worst performing funds showed about the same degree of loss aversion as the individual investors. They were 1.7 times more likely to sell a winning position than a losing position.
Think about these effects the next time you’re considering a particular company. If you already hold stock in that company, you may actually impute a higher value than is warranted, simply because you already own the shares.
“I believe the biggest way you add value as a value investor is how you behave on those down-25 percent situations. Sometimes you should buy more, sometimes you should get out, and sometimes you should stay put. . . . We probably hold tight 40 percent of the time, and split 50/50 between buying more and getting out. ”
“You gotta know when to hold them, know when to fold them, know when to walk away, and know when to run. You never count your money while you’ re sitting at the table, there be time enough for counting when the dealings done.”
The need to focus on process rather than outcomes is critical in investing.
“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.”
The key lesson from these investors is that we must concentrate on process. Process is the set of rules that govern how we go about investing. As we have seen time and time again in this Little Book, some of the worlds greatest investors (from Sir John Templeton ’s research on a quiet day to George Soros’s diaries, from Bruce Berkowitz’s kill the company to Michael Steinhardt’s selling the entire portfolio) have integrated measures into the way in which they approach investment to act as a guard against mindless investing.
