- 4 Deadly Sins of Investors
You've probably heard of the "7 deadly sins"-namely, pride, envy, gluttony, lust, anger, greed and sloth. They are not from biblical reference, contrary to popular belief, but date back to the 12th century when discussed and recorded by Saint Thomas Aquinas. St. Thomas warned that the most deadly aspect of each of the 7 sins was their tendency to lead to the others.
The same holds true today for the 4 deadly sins of investing. If you find yourself guilty of any one of these sins you are likely to be tempted more easily to commit the other three. The 4 deadly sins are - GREED, FEAR, IMPATIENCE & STUPIDITY.
GREED is what moves markets. Greed is the most basic element of playing the stock market with a short-term outlook. Greed is the most deadly of all sins. Greed will lead the investor to making rash decisions without careful thought and consideration. Greed will lead an investor to use margin accounts unwisely, looking to maximize their returns with minimum capital. Greed pushes us to buy the hottest stock in the hottest market, just before it crashes back to reality.
FEAR is the second strongest market mover. Fear makes investors become lemmings, following the latest rumor and trend for fear of being left out or missing a big move. Fear makes us reluctant to chart our own path. We fear going out on a limb to buy stocks we feel are undervalued and out of favor even as we see solid fundamentals under the surface. Fear of loss can even keep us out of the market when we should be in, just as greed keeps us in the market when we should be getting out.
IMPATIENCE causes us to sell when we should be buying. We are often very talented at carefully searching the stock jungle for fine investment candidates, and even buy them. Then, after six months and another earnings release that is right on target with our expectations, the stock price drops another 10%. We lose patience and purge the shares of a perfectly good company from our portfolio and look to invest where there's more action (greed & fear). Common sense and independent thinking would tell us to add to our holdings if the company has grown with expectations and the price has fallen further as an even larger value has been created-and patiently wait for the market to properly value your gem.
STUPIDITY is the final sin. It is usually a result of laziness, a close runner up as deadly sin #5. Technical chartists fall into this category. With no scientific proof to validate any methodologies, they continue to invest based on arbitrarily interpreting the shape of historical pricing charts. This illogical stock analysis fails to bother with understanding the underlying fundamentals of a business, the savviness of their management, their business performance track record, their competitive advantages or their business model and future prospects. No, save time, just view the chart.
So you see, markets have always been and will always be moved by fear and greed, while individual investors are constantly tempted by impatience and stupidity. The investor who can faithfully resist the greed to jump into the hot rumors with borrowed money, deal with the fear associated with independent thought and decision making often against the crowd, be patient with their portfolio companies as long as they meets expectations from a business perspective, and be smart and energetic in their analysis methods-these investors will be without sin, cleansed, purified, holy, sanctified, righteous-and filthy dirty rich enough to afford other sins!
Back in 2006, Michael Dowling wrote an essay called The 7 Deadly Sins of Investors - you can download it via this link here
For me, point 5 or rather sin number 5 was rather important in my view for this is exactly why we see so many investors who likes to remain delusional and not acknowledging what exactly is happening.
- 5. Knowing best (PRIDE)
It is a natural human desire to avoid acknowledging mistakes or losing. This translates into poor investment practice when we are not willing to sell stocks they have bought because they have since fallen in price. Investors do this because they don’t want to have to acknowledge to themselves the mistake they made by buying the stock in the first place. We are reluctant to crystallise losses, a condition known in psychology as Loss Aversion. Modern finance has made huge advances in the last 10 years in modelling and understanding this effect. While we still own the stock, we can convince ourselves that it is only temporarily low in price, and that it will rebound in the future. This can be problematic if it leads to our ignoring negative news about a stock. Similarly, we tend to sell stocks too soon after they have risen in price, even if there is more potential good news for that stock on the horizon. We want to be able to acknowledge to ourselves they have made a successful investment by cashing out and taking their profit. To make matters worse, investors tend to view losses as being determined by external and uncontrollable events, and to view gains on investment as being due to their own intelligent actions. Behavioural finance specialists call this self-attribution bias.
All of this smacks of course of the sin of Pride, an excessive belief in ones own ability. Thus, a lot of investors now view the high prices that stocks achieved in the late 1990s as caused by corporate fraud and deception. By blaming company insiders for the high prices paid for stocks, investors can push the blame for their mistakes onto external factors, and absolve themselves of any fault. However, one main reason for high stock prices in the late 1990s was due to irrational buying on the part of investors. Bitmead shows that the bubble was concentrated in those stocks that were most visible on the internet. Investors, who don’t acknowledge this run the risk of making the same mistake again.
This kind of emotional involvement on the part of investors can lead to them ignoring important news relevant to their investment’s future performance. The best investors keep emotions out of the investment process, although evidence from psychology indicates that persons who are unable to form any emotional attachments are unable to make decisions, so some emotion is necessary, but tempered by reality. These investors simply view each investment as a right to an income in the future. If the share price is excessively high compared to the potential future income from that investment, they will sell. If the share price is low compared to the potential future income, they may consider purchasing the share. Ineffective investors allow emotions to influence their decisions.
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