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FoolStop

Foolstop is an attempt from Safalniveshak to take a light hearted dig at follies of human behaviour especially when it comes to investing your money in stock market. These cartoons appeared first in Value Investing Almanack (VIA). You can click here to subscribe to VIA now.


The word “Moat” is becoming the new fancy jargon among stock market enthusiasts. Just like any other fads people, even with incomplete understanding, become enamoured with new tools and start misusing or rather abusing them.

It’s no wonder that many, including some professional analysts, don’t even understand the meaning of the word Moat. Beware of such charlatans.

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Some people confuse activity with results. They assume that the more time they spend looking at stock prices and following the news, the more knowledgeable they are. So much so that they don’t want to miss even a second of market action.

Of course, when you dance in and out of the market, your brokers are happiest because that’s how they make the money. They would be happy to provide you all the advanced tools to stay glued to market movements.

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This showcases the unethical conduct by financial advisors selling you questionable financial advice (IPO for e-commerce). As a thumb rule, avoid IPOs. Why?

EComIPO-scaledAs history tells, IPOs are almost always bad investments. You are often sold a distant dream at an expensive price.

Warren Buffett says this on IPOs – “It’s almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller (company insiders) to a less- knowledgeable buyer (investors).” 

You’re way more likely to get incredible opportunities in the open market than through IPOs.


 

BloodReport-scaledTrack Your Emotions. Mr. Market is driven by fear and greed. These two emotions are hardwired into human pysche and it’s very difficult to overcome them. Similarly, envy is another negative emotion which is finds its roots deep into human behaviour. Charlie Munger says –

The idea of caring that someone is making money faster [than you are] is one of the deadly sins. Envy is a really stupid sin because it’s the only one you could never possibly have any fun at.

If you can learn to deal with these three emotions – greed, fear, and envy – you are already on your way to a very satisfying long term returns in not only investing but in life as well. Your focus should be on tracking these emotions rather than your daily portfolio returns.


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It’s the staying that counts. Large majority of the investors behave like the school kid here. They like the action of buying and selling stocks. It’s the holding and owning part that bothers them.

But the history of stock market provides ample proof that fortunes are made by buying right and holding on, not by trading in and out of stocks.

“Buy a business, don’t rent stocks.” Warren Buffett has been advising for years. And then he adds, “An investor should ordinarily hold a small piece of an outstanding business with the same tenacity that an owner would exhibit if he owned all of that business.”


The gag here is inspired from a joke that Warren Buffett shared in his 2011 letter to shareholders. It shows how we get so fixated on stock prices that we ignore the basic common sense.

These are the kind of flawed arguments used by unscrupulous brokerage firms and selfish stock advisors to exploit vulnerable investors. A good business that was bought at a price of say Rs. 5 can continue to be a good buy at Rs. 18, but can’t be a “better” buy at this higher price.

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Don’t buy what they sell.  For most people stock research means a hot tip, supported by poor reasoning, by an articulate stock guru on TV or a greedy stock broker. With no independent thinking involved, the decision to buy or sell a stock changes at the drop of a hat for these uninformed and gullible investors. 

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No surprise for guessing that they don’t make any money in stock market. 

Majority of the information provided by financial news and self proclaimed stock experts is irrelevant and unnecessary noise. Similarly taking an advice from your stock broker, whose incentives are aligned to your trading frequency, isn’t a wise thing to do.



exercise-coloredPeople who spend a large part of the day remaining inactive are at an increased risk of grave diseases and early death.

It may be true that the time spent in exercising and staying active may be equal to the extra years that are added to your life. However, what’s missing in this logic is that the overall quality of life for the remaining years increases by a big margin.

It’s not just about living a long life, but living a good quality of life, however long or short it may turn out to be.


Some people take the idea of diversification to an extreme. Research has shown that risk doesn’t go down much after 20 stocks in your portfolio. However, your returns deteriorate rapidly with every new stock you add to your portfolio.

In Peter Lynch’s words – “It’s not diversification anymore, it’s di-worsification of portfolio.” Lynch also said – “Owning stocks is like having children, don’t get involved with more than you can handle.”

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The common trick market forecasters follow is – “If you can’t predict better, predict often.” They go on postulating colourful theories for prediction. If you have even a little understanding of probability and statistics, it’s easy to catch the flaw in the argument here.

The flaw is – if you have hundreds of forecasters predicting hundreds of different outcomes, just by dumb luck some of them are going to end up making a right forecast. The problem is that the gullible small investors, who are glued to the noisy financial news media, supposedly have short memories. They don’t remember about all the predictions which didn’t come true.

And it’s not only ironical but hilarious when some obscure forecaster gets lucky twice in a row, he himself develops an illusion about his forecasting skills and starts betting his own money too.

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Sales experts often go to any extent to use the behavioural biases to exploit their customers. Munger says, these psychological errors usually work together to create a lollapalooza effect. 

It’s amusing that the we, the gullible customers, fall for biases like social proof (one million people buying the same product) tendency and scarcity bias (limited edition) leading to irrational decisions.

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It shouldn’t be a surprise to you that the incentives for most of fund managers aren’t really aligned to that of investor’s. The remuneration for majority of the money managers is directly proportional to the size of the fund they manage. So it’s obvious that their first goal is always to increase the fund size.

There are very few ethical fund managers who, in spite of the misaligned incentives, are genuinely concerned about investor’s interest. If you can find such investment managers, you should stick to them.

For that matter the fee structure of Buffett’s Partnership, which he ran from 1955-1969, was designed in such a way  that he would only get paid if the fund returns crossed certain threshold for the investor, and that too wasn’t related to the AUM. It’s sad that very few people seem to follow Buffett’s style of fee structure.

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There is no substitute for hard work. Even then some investors (including very experienced ones) try to compensate their ignorance with over diversification.

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What they don’t realize is that it’s a loser’s game. Research has shown that adding more than 20 stocks in your portfolio doesn’t reduce the risk much, however it reduces the returns significantly.

Diversification is a method to protect your downside against the risk arising out of uncertainty. Diversification is not a replacement for hard work and rational thought process.

There is a fine line between diversification and diworsification. Don’t cross the line.

If you read the annual reports, as Jim Rogers suggested, you are already in top 95%.


 

How you frame the question is very important. “Framing effect” has strong implications on our behaviour. People find “99% fat free” products enticing but if the same message read “contains 1% fat”, it would trigger a different response from the same people.

Make sure you look at problems from multiple vantage points.

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Here is question for you – how much do you think the poor husband saved? Rs. 50 or Rs. 200.

OpportunityCost-scaledI guess it doesn’t require superhuman IQ to answer this question. Of course the husband saved only Rs. 50. If the cost of travelling from his office to home was Rs. 10,000 using a helicopter, doesn’t mean he saved Rs. 10,000.

 

His circle of competence was traveling by bus. As value investors, our circle of competence is finding good businesses run by ethical management and then let our money compound over long term. If somebody is making quick and easy money in day trading or derivatives (akin to traveling by taxi here), it’s not our opportunity cost.

Don’t compare your investment performance to some other money making strategy which you don’t understand.

Stick to your circle of competence.


 

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