We conducted our Value Investing Workshop in Ahmedabad yesterday, and here are the tribe members…
“And how did you do that?” the surprised wife asks.
“I missed the bus and ran behind it all the way from office to home.” The air of pride was palpable in the husband’s voice.
“Well, then you should have chased a taxi and saved 200 bucks!” the wife said. And her logic was spot on, wasn’t it?
Here is question for you – how much do you think the poor husband saved? Rs 50 or Rs 200? Extending the wife’s argument, the guy could have chased a Limousine and saved Rs 2,000. Do you see the absurdity of the logic?
Although it’s a joke but more than that it’s a sarcasm for those who are always worried about missing the taxi. That chronic anxiety about losing something which is either irrelevant or outside your reach is called FOMO or Fear of Missing Out.
This has a very strong implication in investing. Let me share my own experience which many of you can relate to.
In July 2010 when I first started investing money in the stock market, one of the first books that I read was Peter Lynch’s One Up On Wall Street. I loved his idea of finding businesses based on observing things around us.
I love eating Domino’s pizza. So Jubilant Food Works (which owns Domino’s in India) was one of the first few businesses that I started studying. The problem was that I knew nothing about analyzing a business nor did I have any skills in stock valuation. So even though I liked the pizza and Jubilant’s business, I couldn’t figure out if the stock was worth buying for Rs 300 (the price then). So I gave it a pass and kept the cash, which I had earmarked for Jubilant, in a bank fixed deposit.
Fast forward to July 2012. My fixed deposit had earned 6 percent (post tax) but Jubilant’s stock was trading at Rs 1,200. It had quadrupled in 2 years. Had I invested Rs 10 lac in it, it would have turned into Rs 40 lac. That was a huge loss of Rs 30 lac, or so I thought.
It took me a long time to understand this distinction that Domino’s wasn’t really a missed opportunity. It was never in my circle of competence, for two reasons – (1) I didn’t understand Domino’s business and its valuation in 2010. So buying it would have been an act of speculation. (2) I never had Rs 10 lac to invest in the first place so it wasn’t really a loss of Rs 30 lac. Remember the bus vs. taxi logic I shared above?
But the fear of missing out was so strong that I bought Jubilant in July 2012. I still couldn’t tell if the stock was worth Rs 1,200 but I didn’t want to miss my taxi again!
Fast forward to July 2014. Jubilant’s stock hadn’t budged an inch. That made me research it further and I learned that a very small percentage of the company’s outstanding shares was owned by retail investors and rest by promoters and large FIIs, who had no plans of selling their stakes. Which means, inspite of being a good business, the price-value gap may not close for a long time. But the point wasn’t that. I had bought the stock for wrong reasons. FOMO was driving my decision.
But now I could say that my opportunity cost for owning Jubilant was at least 6 percent. Had I invested my money in fixed deposit, I would have at least earned 6 percent. Fixed deposits are well within my circle of competence. That was my true opportunity cost.
FOMO in Investing
The lesson is things which are outside our circle of competence aren’t potential opportunities. In other words, missing a 10-bagger (which was outside your circle of competence before it became a 10-bagger) is not the same as missing a 2X opportunity which is inside your circle of competence.
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 someone is making quick and easy money in day trading, derivatives, real estate etc., which is akin to traveling by taxi, it’s not our opportunity cost.
So what’s a better option to invest your money?
- In bank deposits earning 7 percent interest;
- Mutual funds earning 12-15 percent returns;
- Investment in fundamentally strong businesses earning 18-20 percent; or
- Derivatives promising 25-40 percent returns.
All things being equal, the last option is a no-brainer. Isn’t it?
The answer isn’t as easy as you would hope it was. Because all things are never equal for an investor. Before answering the above question, what’s even more important to know is the certainty of the return in each case. In other words, what’s the risk?
Here’s a brilliant insight from Prof. Sanjay Bakshi –
Should we reject projects that are within our circle of competence and which promise to deliver a return of 20% p.a. just because some other projects that are outside our circle of competence promise to deliver a higher return, say 25% p.a.? In other words, should we allocate capital based on our own ability to understand the fundamental economics of the project, or should we look over the fence to see what the other fellow is doing, and if he is doing better than us in things we do not understand, should we feel envious and not do something sensible that will, over time, make us rich?
So one of the more basic emotion underlying FOMO is envy. It’s human nature to feel envious about the grass which is greener on the other side of the fence.
To quote Charlie Munger, who said the following in 2000 –
There’s one big truth that the typical investment counselor will have difficulty recognizing but the guy who’s investing his own money ought to have no trouble recognizing: If you’re comfortably rich and you’ve got a way of investing your money that is overwhelmingly likely to keep you comfortably rich and someone else finds some rapidly growing something-or-other and is getting richer a lot faster than you are, that is not a big tragedy. And if you’re not comfortable and don’t understand the fact that somebody else is getting rich faster, so what? How crazy it would be to be made miserable by the fact that someone else is doing better because someone else is always going to be doing better at any human activity you can name. Even Tiger Woods loses a lot of the time.
And, on another occasion, he said –
Suppose, any one of you knew of a wonderful thing right now that you were overwhelmingly confident- and correctly so- would produce about 12% per annum compounded as far as you could see. Now, if you actually had that available, and by going into it you were forfeiting all opportunities to make money faster- there’re a lot of you who wouldn’t like that. But a lot of you would think, “What the hell do I care if somebody else makes money faster?” There’s always going to be somebody who is making money faster, running the mile faster or what have you. So in a human sense, once you get something that works fine in your life, the idea of caring terribly that somebody else is making money faster strikes me as insane.
Apart from envy, Mr. Munger, of course, is referring to the fundamental ignorance of an enormously important mental model from mathematics – the power of long-term compounding. As Prof. Bakshi writes –
Even small sums of money, when compounded at a rapid rate over the long term, become enormous, regardless of how much more rapidly, someone else is compounding money. And, if you are competent enough to compound money at a rapid rate, simple arithmetic shows that you’re going to become rich. And if that outcome is virtually certain, then how in the hell does it matter, if someone else got richer than you? Of course, it doesn’t. But try telling that to the capital allocators of the world – corporate boards or investment committees of institutional money managers.
Don’t compare your investment performance to some other money making strategy which you don’t understand. Stick to your circle of competence.
In spite of knowing this, FOMO remains a powerful motivator. It causes even smart investors to do stupid things. It leads to poor decision making not only in investing but in many other areas of our lives.
It is not uncommon for advertising and marketing campaigns to employ the appeal of FOMO. Brands and companies often inform their customers of “can’t miss out” experiences or deals.
One very common marketing technique is to include a countdown timer as a way to explicitly show customers how long they have until they miss out on the sale. Like those latest smartphones available online on Wednesday flash sales. Look at the comments people leave on popular e-commerce web sites for such flash sales products. Most people are upset not because of the product or service but because the item went out of stock before they could buy it.
FOMO keeps us using social media – “What if I miss that important news story or fall behind what my friends are talking about?”
But if we drill down into that fear, we’ll discover that it’s unbounded. We’ll always miss something important at any point when we stop using something.
Living moment to moment with the fear of missing something isn’t how we’re built to live. And it’s amazing how quickly, once we let go of that fear, we wake up from the illusion.