On the morning of the Battle of Waterloo in 1815, Napoleon Bonaparte smugly assured his generals – “I tell you Wellington is a bad general, the English are bad soldiers; we will settle this matter by lunchtime.”
Just before the Titanic was about to embark on its maiden journey in 1912, one passenger asked a ship’s agent for extra insurance on some valuables in her luggage. The agent replied, “Ridiculous. This boat’s unsinkable.”
Captain Smith himself was asked about the safety of the Titanic. He answered – “I cannot imagine any condition which would cause a ship to founder. I cannot conceive of any vital disaster happening to this vessel. Modern shipbuilding has gone beyond that.”
Then, after the ship had struck the iceberg, a passenger asked her employer if they should do something about it. He replied, “Go back to bed. This ship is unsinkable.”
The New “Unsinkables”
Cut to 2008. Fund managers in India who were betting big on infrastructure and realty stocks, when asked about the valuations at which they were buying such stocks, said, “Real estate and infra are the new gold and prices will continue to head north.”
Ask me. As an analyst in 2008, I asked my friends and relatives to hold on to “great stocks” expecting that these cannot fall more than 20-30%, whatever the markets did.
As a team at my ex-employer, we were asking clients to hold on to stocks, and “buy at every dip”, despite sensing a greater danger with every “breaking news” coming out of the financial system.
The rest, as they you know, isn’t history…but reality!
Anyways, if you have sensed by now, there is a common thread that binds all the above situations and events. If not, let me tell you that that common thread is of…
If we’re repeatedly successful – like Napoleon, or fund managers and analysts prior to 2008 – we’re tempted to believe that we’ve found the formula for success and are no longer subject to human fallibility. This is devastating, especially in a world that is continually changing, and where every right idea is eventually the wrong one.
With an arrogant attitude, we cease paying attention to different points of view and information that contradicts our beliefs. Even if the world around us is expected to fall under its weight, we believe we’re not subject to the same constraints as others.
“I have done my homework,” I would tell myself after analysing a stock threadbare and finding its valuations attractive. “Now let me act on it!”
But I Might Be Wrong
Now, that’s something Napoleon didn’t tell himself before the Battle of Waterloo. That’s also what Captain Smith didn’t consider before sailing out with his “unsinkable” Titanic.
Here is what the legendary Seth Klarman wrote in his shareholder letter in 1996…
We regard investing as an arrogant act; an investor who buys is effectively saying that he or she knows more than the seller and the same or more than other prospective buyers.
This statement contains a big truth that I, as an investor, ignored all these years.
So I bought a stock because I thought my analysis was right. I thought my calculation of the stock’s intrinsic value was right. I thought my decision to buy the stock was right even when I always wondered what could be the reason someone else was selling the same stock.
All in all, my arrogance – of being right – made me buy several stocks over these years.
While I’m satisfied with my long term returns, I consider a large part of my performance a result of luck than my own aptitude of picking up the right stocks.
“Why do you say so?” you may ask.
Well, the reason is that in considering myself the most right (and thus the most arrogant) investor in the world, I often failed to tell myself the most important thing that an investor must tell himself before buying or selling a stock.
That thing is – “But I might be wrong!”
This statement now lies at every major decision point of my investing checklist…
- After I’ve done my research on a company
- After I’ve calculated a stock’s intrinsic value
- Before I make the final decision to buy a stock
After providing for a numerical “margin of safety” to my intrinsic value estimates, this statement serves as an extra layer of margin of safety – a check on my arrogance…because it leads me to do a review of my analysis and assumptions before I go ahead with my final decision.
Here is what Klarman said in an interview with Charlie Rose in 2012…
You need to balance arrogance and humility…when you buy anything, it’s an arrogant act. You are saying the markets are gyrating and somebody wants to sell this to me and I know more than everybody else so I am going to stand here and buy it. I am going to pay 1/8th more than the next guy wants to pay and buy it. That’s arrogant. And you need the humility to say ‘but I might be wrong.’ And you have to do that on everything.
This is an interesting concept, and one that I, like most investors, did not fully consider when purchasing a stock (though I’ve now learnt my lessons).
Risk is Not in Our Stocks, But in Ourselves
Jason Zweig, in his commentary for Chapter 20 of Benjamin Graham’s The Intelligent Investor, wrote…
Risk exists in another dimension: inside you.
If you overestimate how well you really understand an investment, or overstate your ability to ride out a temporary plunge in prices, it doesn’t matter what you own or how the market does.
Ultimately, financial risk resides not in what kinds of investments you have, but in what kind of investor you are. If you want to know what risk really is, go to the nearest bathroom and step up to the mirror.
That’s risk, gazing back at you from the glass.
Staying humble with your analysis and forecasting powers will keep you from risking too much in a view of the future that may well turn out to be wrong. So, by all means you should lower your expectations – but take care not to depress your spirit.
For the intelligent investor, hope always springs eternal, because it should.
I’ve learned these important lessons by being an arrogant investor in the past. Now, I’m practicing to be humble…by telling myself this before making an investment decision – “But I might be wrong” – and double-checking my analysis and assumptions.