Saturday, January 03, 2009

Don't Let Intelligence Breed Dumb Investing Mistakes

Here is a classic investment article posted back in 2004. It was posted on IBD, Investor's Business Daily. Sorry, I do not have the link anymore.

  • Don't Let Intelligence Breed Dumb Investing Mistakes
    Tuesday April 20, 10:54 am ET
    By Craig Shaw

    Sir Isaac Newton lost money in the South Sea bubble of the 18th century. Mark Twain squandered his fortune speculating on inventions and real estate. Plenty of Ph.D.s and M.D.'s saw their nest eggs shattered in the 2000-02 bear market.

    The lesson? A high IQ often means little when it comes to investing.

    After his experience, Newton said, "I can calculate the motions of heavenly bodies, but not the madness of people." Albert Einstein once said, "Only two things are infinite, the universe and human stupidity, and I'm not sure about the former."

    Some people with big intellects also have big egos. They're used to figuring things out more quickly than others. They probably raced through school with little effort.

    But there are no born experts when it comes to stocks. Successful investors learn by trial and error. When they make a bad trade, they figure out what went wrong. They analyze past performance to determine how to improve their odds.

    Professors love to build models to explain how the world works. But human emotions rule the market, not logic and intellect. The market is a collection of millions of investment decisions made each day by millions of people. The vast majority of those decisions are based on emotions like fear, hope and greed.

    "University economics professors are exceptionally bright, intelligent, valuable people, but many have little realistic understanding of the stock market and even less highly profitable experience in it," wrote IBD founder William O'Neil in "The Successful Investor."

    "Many have never run a successful business. Instead, they may frequently tend to cling to theories and academic beliefs that haven't necessarily worked out so well in the realistic but contrary battlefield of our auction marketplace."

    Likewise, Wall Street is full of top-level analysts with Ivy League MBAs. They're used to being told they're right. So why did they repeatedly advise clients to buy plummeting stocks in the 2000-02 bear?

    The people who do best in the stock market tend to be humble and hard working. They admit their mistakes and learn from them. They set ego aside and don't assume they always have the answers.

    Academics favor elaborate models and formulas. But don't miss the forest for the trees. Successful investors keep it simple, making the market's daily price-and-volume action their cue. When a stock falls 7%-8% from their purchase price, they don't compose a dissertation on what went wrong: They sell.

    Benjamin Graham wrote in "The New Speculation in Common Stocks," published in 1958, that "in 44 years of Wall Street experience and study I have never seen dependable calculations made about common stock values, or related investment policies, that went beyond simple arithmetic or the most elementary algebra.

    "Whenever (calculus) is brought in, or higher algebra, you could take it as a warning signal that the operator was trying to substitute theory for experience," Graham wrote.

Yup and intelligent investing is not based solely on yardsticks such as PE alone.

If you invest just because the PE is low, you are merely 'investing' based on 'numbers'.