We always have a dilemma to our mind that we need to be intelligent to become a wise investor. But does it a reality? Do we really require to be an immense intelligence for the decision making to investing field? We have an example of a few highly intelligent person who has intelligence but lack of the real skill which needed to become a wise investor. I am going to explain it to the current article. Isaac Newton also cannot be saved from emotional biases such as greed and fear, though he has a brilliant mind.
We should understand that a higher IQ, intelligence does not protect us from the emotional biases. We need to be a master of emotional biases for earning money through investment. If we do not have mastery on our own emotion then we incur losses into the investment.
We have seen that the winner of the Nobel prize in economic of Long Term Capital Management (LTCM) also failed terrifically. They count as a genius mind during an era. During a tough time, their leverage position reaches the 100:1 which has killed the entire business.
No model is perfect which can capture behavioral aspects of human. But we keep focusing on the same that our constructed model is going to capture all the madness and which make us mad. LTCM failure teaches us that we should not be overconfident to our model, we should focus on the risk management and we cannot capture the behavioral aspects of human. So that we should have control on own behavioral aspects that can help us for a longer period of time. Our intelligence should not be getting converted to the overconfidence, and if getting converted then it will definitely going to harmful for our investment career. Rather if we have a control on to our emotion then it will be going to help to our investment career though we have a little intelligence.
We have seen in all article series of “The Most Important Thing” that Mr. Howard Marks is always keeping focusing on the avoiding losses. If we can able to avoid losses then our investment success will come to us.
When we are going to focus on the risk and avoidance of risk then there is a chance of under-performance of our investment portfolio during the bull phase of the market. But also we can able to get protected from the worst situations coming into the future. We can able to get survived into the market for a longer period of time.
For avoiding losses, we need to avoid the pitfalls which invite the losses. And sources of pitfalls can be analytical/intellectual or psychological/emotional.
Looking at the analytical/intellectual error – such error occurs while we collect too less information, uses wrong analytical methods, wrong approach, computational error, etc. Such errors wrongly direct the result and tend us to make a wrong decision.
One type of analytical error which is called by Mr. Howard Marks is “Failure of imagination”. This error means we cannot able to imagine or little in imagine full range of outcomes or not understanding consequences of occurrence of the extreme events.
“Failure of imagination” is the inability to understand the different range of outcomes in advance. In investing, we need to be dealing with the future and many a time, we try to assume that future will be similar to the recent past.
Most of the time future looks like the past so assuming it does not harmful to us. But what happens while future will not repeat the scenario as similar as happens in the past, either we have to lose huge money or no money made by us.
Events might occur or might not occur or it take times to occur compared to what we have assumed.
While we largely depend on the certain outcomes to happen in our investment then not occurrence of those events can kill our investment. So that we should always try to focus that if certain events do not occur then also we should not lose our huge money. We should focus on controlling our risk.
During sub-prime crisis also things do not work as it should work which resulted in a global meltdown. During sub-prime also investors believe that risky situations do not go to happens and securities are backed by assets based mortgage which encourages the risky behavior of investors. Majority of the investors did not expect that value of backed assets also can befall.
We should make an investment which can protect us against deflation and hyperinflation situations. We should not always a stick to the cash, treasury or gold to avoid pitfalls. But as a when requires, we should shift from defensive to offensive and offensive to defensive.
It is important to avoid pitfalls but there must be a limit which differs from each and every investor.
One of the psychological factors is GREED. Excess of greed tends to be higher security prices. We want to make a more money and for that, we keep on buying an asset though it’s price trading at a higher range. We believe that assets will keep on appreciating into the future.
The second psychological error can be an error of not noticing. Sometimes we have a plan to steadily invest in the stock market. And we ignore the undisciplined buying by others has created a boom.
The third error can be not consistent with doing a wrong thing but failing to do a right thing. Average investors just being a fortunate enough by avoiding pitfalls. While superior investors avoid it and also take an advantage of it.
Our psychology resists us from accepting novel rationale and keep believing that “It’s different this time.”
The way pendulum swings, people forget to be skeptical every time rather believe that things keep on doing well.
The combination of Greed and optimism lead us towards the adoption of strategies which provides a higher returns without taking a higher risk. Pay higher prices for the securities with the hope of still left with an appreciation.
Just knowing about the pitfalls provide helps to us to some extent but the implementation of it leads towards success.
We should always learn the lesson and remember it throughout our journey. Mr. Howard Marks pointed out eleven lessons such as –
We should always be focusing on the things surrounding us. Excess supply of investment funds will lead to the situation called – “too much money chasing too few ideas”. Such situations can be dangerous for our financial health and we need to be careful during such situations.
When people become careless, investors not worried or skeptical about events, everyone becoming more bullish, increasing leverage. But we have to always keep in mind that such scenario will be going to reverse, it will never remain forever of the same magnitude.
It is near to impossible to avoid downfall but we can able to reduce our pain.
When we loss less than others then it provides a benefit to us such as we can able to maintain equanimity with others, able to avoid a psychological pressure and can able to generate higher profit by buying at a lower price.
Surviving during the declines provides us an opportunity to buying an asset at the low price. But for achieving success through this formula, we need to avoid pitfalls.
The way errors can appear to us is infinite but some of them are quoted by Mr. Howard Marks. Such as data or calculation error in the analytical process, ignoring the full range of outcomes or probability of occurrence of events, psychological factors (I.e. greed, fear, envy, ego, etc.), extreme risk-taking or risk avoidance behavior, etc. The second level thinkers can able to understand errors and also can able to detect over or underpriced assets. They can take a proper benefit of it and also take benefits of errors from others.
Errors are moves around us, sometimes assets prices reach a higher level or reach the lower level, sometimes such extreme scenario happens with entire market, sometimes to individual securities. Sometimes an error occurs while we do something and sometimes doing nothing leads to an error. So that error is around us and without any errors, there will be no occurrence of any events.
All above-discussed points don’t indicate rules for avoiding pitfalls but it provides us an awareness, flexibility, adaptability, and mindset to take the cue from our surrounding environment. There are times where few of our acts resulted in errors.