“Put ourselves in the way of good luck” as opportunities only come around once in a while and we have to take those opportunities.
Category Archives: Behavioral Finance
We all know that temperament is one of the most important quality not only in the investment field but also in our life. If we work on our emotional biases then we can win any battle. To excel in temperament, first, we need to be aware of the various biases. So now onwards, I will illustrate various biases and how we can excel it and use it in our life. This entire series will be review with various examples from books which are “Thinking, Fast and Slow” and “The Art of Thinking Clearly”.
We get many predictions from around the globe daily. Many come true, many fall nearer, and many fail. ‘There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know
If these predictors are proven right then they get publicity but if they fail then there is no penalty to them. So, it’s a win-win approach for them. Thus, they are bombarded with lots of predictions.
Investment – We get many tips on a routine basis from the different analysts/agencies. If there does not have any penalties for failure then people keep on sending as many as possible predictions or tips. Any tips will hit the target and they become famous. As everyone remembers success, not failure. If their increments, incentives are based on how many times they achieve success so that they are remains in control.
But we do not know every time that is their tips providers have something to lose or not? So that we should not trust every coming prediction blindly. We need to study all the predictions with our knowledge and process before accepting them.
Alternative paths are all the outcomes that could have happened but did not. When we reach somewhere with one path but there are different paths or possibilities which is invisible and that can happen. But did not happen. If any alternative paths have happened then it has a possibility that we might not reach a destination or ruin in a way or reach faster or reach slower.
There can be several permutations and combinations for the occurrence of any events. If one event out of those numbers of combinations happens then it does not mean that another event cannot happen.
Let’s try to explain the concept with an example of the “What If…?” series of Marvel Cinematic Universe (MCU). We all know that how Mr. Tony Stark has become the Iron man in an MCU movie after he was kidnapped.
Its “What If” series has shown that, if Tony Stark was not kidnapped then he might not come out as Iron Man. We cannot be denied the occurrence of alternative events.
So does not the occurrence of one event has changed the entire story of Iron Man. Similar way, our life also has many alternatives to happen.
Investment – When we have gained through investment, we need to understand that there can be many alternative ways that have not happened. And that does not mean that we have not taken the risk.
Risk is not directly visible. Therefore, always consider what the alternative paths are. The success that comes about through risky dealings is, to a rational mind, of less worth than success achieved the ‘boring’ way. People only think about success but there can be different possibilities that need to focus on.
I know a few of my friends who bet on the company where the occurrence of some event can help the company to earn revenue (earlier no revenue). But what if the event does not happen? We must have to be ready for the occurrence of an unexpected event. Do we have any substantial margin of safety when the assumed event does not occur? Do we have at least winter soldier (chance to not lose much) if Tony does not come out as Iron Man?
When we make any assumption about investment, we also should prepare alternative events which can happen. There should be a scenario analysis while making any investment decision. (What If Tony Stark do not become Iron Man 😉)
The halo effect occurs when a single aspect dazzles us and affects how we see the full picture. When we like something about some person then we start liking many things about them, also things which we may not observe about them. This is known as the halo effect.
When we meet someone and like him/her then slowly our emotions make more sense of liking various things of them which may or may not be observed by us. Or that may not be real. Reversely if we dislike the person or something at first impression then later on we tend to dislike more things about the same though it may be good.
The parable of the blind men and an elephant originated in the ancient Indian subcontinent, from where it has been widely diffused. It is a story of a group of blind men who have never come across an elephant before and who learn and imagine what the elephant is like by touching it. Each blind man feels a different part of the elephant’s body, but only one part, such as the side or the tusk. They then describe the elephant based on their limited experience and their descriptions of the elephant are different from each other. – Wikipedia
Investment – We see single elements to create an entire picture. Such has happened during the IT bubble and infra bubble. When prices of IT companies started rising, people think that IT is a new era, the world will be going to change and IT stocks remains shining forever. Same with infra, shortage of land, affordable housing, nuclear family, etc. But when the bubble got burst people started with different stories.
We should try to study all aspects in detail so that we do not make such mistakes of using one attribute as an entire story. If we have focused on one attribute and ignored others then we will be at a mercy of luck which might result in huge regret in the future.
Our first impression has a greater impact on our future perception of the same things. We should write down things which have an impression on our minds. And help system 2 to take charge. This makes us able to make a wise decision rather than fall into the first impression trap.
When we start with the company study and we found some liking features, later on, we like many things about a particular company. That may or may not be true. We have to be suspicious from starting and giving control to system 2. We can write down things that are making us biased and work on collecting disconfirming evidence. We should have worked on the scorecard method and given scores to every fact about the company. So that the end score can drive our decision rather than the halo effect.
The winner’s curse suggests that the winner of an auction often turns out to be the loser. When we bid on something for winning it then over some time, we start buying things at a sky-high value and that will end up as losers.
Business – when businesses adopt heard behavior and they see other businesses start acquiring businesses. So, they also involve buying businesses at a higher price to win the competition. Businesses win other businesses for time being but due to the higher price paid by them, this bid will result in a troublesome situation in the longer term. We have seen lots of high-priced acquisitions made by businesses that turn out to be trouble creating for the core business.
Investment – IPOs, mergers, and acquisitions are part of the winner’s curse. As they offer the part to them who bid higher. So that winner gets stake of the company but the majority of the time, winner get it at a higher price and that ultimately losing things. During the regular buying of stocks, we have many buyers who wanted to buy a stock. So, one put a higher bid compared to others for buying it first so the last bidder comes as a loser. The current scenario is similar to the winner’s curse, with many high-priced IPOs floating to the bourse and people chasing it heavily. We don’t that many of those will survive in the future or not. And if survive then what will be the return going forward.
As Mr. Buffett has advised that we should not go for auction. If we have to go for it then first decide the maximum value then deduct 20% from it and do not bid a single penny on that deducted 20% amount.