Investing Behaviour

I met a 26-year-old investment analyst yesterday, who sought my single biggest advice to, well, a 26-year-old investment analyst, on what she should be doing to do well in her career as an analyst and an investor.

Despite being involved in this work for the past 11 years of offering advice even when I am not asked for, her question led me to think, and so I sought some time to get back to her with my response.

There are, after all, so many things I can advise to a young investor or analyst, based on what I have learned in the past 17 years, that is, since I was 26 myself –

• Invest with an inner scorecard – Don’t change who you are to fit in.
• Have courage, even in the face of adversity – and there are a lot of adversities you would face in investing.
• Accept whatever outcome you attain, for what’s in your control is how you react to the outcome, and never the outcome itself – you can either rue over a bad outcome or take it as a lesson and move on.
• Keep learning, for nothing builds an investor’s career better than continuous learning. Learn from your own experiences and mistakes but more importantly from the experiences and mistakes of others.
• Avoid predictions, because you are rarely going to make a correct one. Also work with the intellectual humility that you know nothing, even if you are the smartest person around.
• Be patient, like a grasshopper, for that is how wealth is created.

All this is very useful advice. But since I have to offer just one advice as requested by that young investment analyst, it would be something that I learned from Charlie Munger and Warren Buffett many years ago –

Not losing money is a critical part of the stock investing process. Successful investors say it in different ways, but the point is always the same.

Warren Buffett has often said – “Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.”

But he has also said – “If you don’t make mistakes, you can’t make decisions.”

You see, the problem is not in making mistakes. The problem is in not knowing when you have made a mistake and thus not learning from it.

Unfortunately, openness to making mistakes and recognizing them is beyond most of us. Why is that?

Two reasons. The first, our society’s phobia for making mistakes, something that begins at school, where we learn to learn what we are taught rather than to resolve problems. We are fed with facts, and those who make the fewest mistakes are considered to be the smarter ones. So we learn that it is embarrassing to not know and to make mistakes. We feel bad when we find out we have made a mistake or do not know something.

Coming from a Marwari business family, I have grown up on the idea of ‘opportunity costs,’ which is simply the value of the lost opportunity, or the benefit of the thing you could have done instead of what you are doing now.

For a Marwari businessman, opportunity cost is at its most expensive when he misses opportunities. Standing by as something important is happening without him, or not moving funds to where they are most productive, are like wasted opportunities. Most Marwari business houses act like venture capitalists and keep scouting for opportunities to grow and for their heirs to run.

I keep receiving questions from readers about what they should be doing with their investments, and more so when the markets are falling. Here is my attempt to answers a few such questions I have received over the past few days.

You won’t find perfect answers below, but this is just my attempt to help you get over your fears, which may otherwise lead you to act in haste, which can cause some damage to your process of long term wealth creation.

Let’s start right here.

1. Why is the market crashing?
It hasn’t crashed…so far! The BSE-Sensex is down just 11% from its peak one-month ago. And so are the BSE-Smallcap and BSE-Midcap indices. 11% down isn not a crash!

If you think it is, you maybe be suffering from ‘denominator blindness’, which is the tendency to focus on the absolute number than the percentage decline. Or you just seem to have been spoilt by rising markets over the past few years, that a 11% fall seems like a crash.

I still see rampant speculation and short-termism around. Like Warren Buffett said at the recent Berkshire meeting –

My general assumption — there’s no way to prove it — but essentially, people are now behaving somewhat more tribal than they have for a long time. It’s fun to participate in, but it can get very dangerous when people say two plus two is five and the other says two plus two is three, you know, and they’re gonna give you those answers.

I also see companies with extremely poor financials and track record are quoting at market capitalisations and valuations more than much established, profitable, dividend paying companies. So, we are still not on a slippery slope as of now.

Focusing on what can go wrong has long been a mantra of sound investing.

The legendary investor Seth Klarman put it the best in an investor letter –

We are big fans of fear, and in investing it is clearly better to be scared than sorry.

But chances are that even the biggest pessimists among us can have their focus on risk muted by extended periods of generally favourable market conditions.

This is an excerpt from my upcoming book – Shut Up and Wait: And Other Timeless Principles to Win at Investing and in Life – which I aim to release in August 2022. Click here to read more about the book and download five chapters.

One of the most important lessons I have learned as a writer is that every great story, bestselling novel, or a blockbuster movie’s screenplay began with a ‘premise, that, in simple words, is the foundational idea that expresses the plot in simple terms.

A strong premise in writing or storytelling ideally includes three elements. First, the description of the main character or protagonist of the story – “misfit team of deep-core drillers.” Second, the protagonist’s goal – “save Earth from the impact of a large asteroid.” And third, the situation or obstacle the protagonist find themselves in – “how to destroy the asteroid the size of Texas.”

A good premise serves as both a hook for the reader or the audience and a guiding light for the writer, providing a storytelling roadmap from the start of a story to its end.

One of the biggest flaws in my decision-making process caused me a lot of anguish and a few losses in the early part of my investing career.

It was the idea of averaging down or buying more of the stocks from my portfolio after they fell from my original buying prices just so that I could ‘average down’ my costs.

The math is simple. Assume you buy 100 shares of ABC Co. for ₹120 per share. Your total investment is ₹12,000. The stock falls to ₹90, because the stock market falls, and you buy 100 more shares. Your new investment is ₹9000. Your total investment is ₹21000 (12000 + 9000) and for a total holding of 200 shares, your average cost now stands at ₹105. You have ‘averaged down’ your cost.

Now, this is not a problem if the underlying business remains good but the stock has fallen just because the overall market has taken a hit.

Anyways, ABC Co. falls from ₹90 to ₹60 because there is a rumour in the market about some mismanagement in the company, but you ignore that. You buy 100 more shares for a total investment of ₹6000. Your total cost now is ₹27000. Your total holding is 300 shares. Your average cost of total holding is ₹90.

You feel happy seeing your average cost come down, from ₹120 for the first transaction to ₹90 for the total of three transactions.

…is almost always more profitable than investing when everything seems certain.

Investors, like most people going about their daily lives, don’t like doubts and uncertainties – like the Covid-19 pandemic, or the Russia-Ukraine crisis. So, we would anything we can to avoid it.

Of course, it’s a good idea to avoid entirely what you can’t totally get your mind around, successful investing is largely about dealing well with uncertainties.

In fact, uncertainties are the most fundamental condition of the investing world.

Seth Klarman wrote in Margin of Safety –

Most investors strive fruitlessly for certainty and precision, avoiding situations in which information is difficult to obtain. Yet high uncertainty is frequently accompanied by low prices. By the time the uncertainty is resolved, prices are likely to have risen.

Investors frequently benefit from making investment decisions with less than perfect knowledge and are well rewarded for bearing the risk of uncertainty. The time other investors spend delving into the last unanswered detail may cost them the chance to buy in at prices so low that they offer a margin of safety despite the incomplete information.

What Klarman suggests is that if you need reassurance and certainty, you’re giving up quite a bit to get it. Like high fees to experts who would predict the future (which you falsely believe as certainty, which it isn’t), or expensive prices for stocks (because everyone knows their future is clear, which often isn’t).

On the other hand, if you can get in the habit of seeking out uncertainty, you’ll have developed a great instinct. Plus, in the long term, it’s highly profitable.

This is an excerpt from my upcoming book – Shut Up and Wait: And Other Timeless Principles to Win at Investing and in Life – which I aim to release in August 2022. Click here to read more about the book and download five chapters.

The small town I was born in West Bengal gets occasional loud and wild mud storms. Growing up there in my early years, though, no one really freaked out about it, not even the people residing in small mud houses surrounding my house.

They had built their houses so strong that any wild storm was rarely a problem. And so was the attitude towards the storms, that it was hardly a problem worth getting nervous about.

The case with the place in Rajasthan where I grew up in my teens was different. Temperatures during summers peaked at 50 degree Celsius, and dropped to 5 degree during winters. But we rarely went crazy because we had learnt to prepare for and live with both the extreme seasons.

Now, the weather where I have lived for the past 21 years i.e., Mumbai, is so humid throughout the year that people travelling from North India, who do not get freaked out about the extremes there, find Mumbai terrible. On the contrary, I find Mumbai’s weather much more comfortable than the extremes of the places I grew up in.