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Taking control of your own finances can be hugely rewarding. But it is also permeated with investing mine traps that could potentially derail your returns. 

Even seasoned investors and professional portfolio managers are not immune to these pitfalls.

Many of these are innate behavioral human tendencies that create delusions and lead to investment errors.

Jason Zweig, the author of the best selling book, Your Money and Your Brain, said, “Humankind evolved to seek rewards and avoid risks, but not to invest wisely. To do that. You’ll have to outwit your impulses – especially the greedy and fearful ones.”

With that said, here are three common human tendencies that may impact our investing.

Making gross generalisations

The human brain makes sense of the world by recognising patterns. But when it comes to investing, assuming a pattern when there really isn’t one could be detrimental.

Carolyn Gowen, a well-respected financial advisor, recently wrote in her blog that “in investing, we often mistake random noise for what appears to be a non-random sequence.”

To lower the chance that we mistake a random sequence for a pattern, we should look for real economic reasons behind a correlation.

Second, never rely on short-term data. Investing should be viewed in decades, rather than months or years.

Herd mentality

Humans are social creatures. We want to be included and accepted. It is, therefore, not surprising that herd instinct is a common phenomenon in investing.

Investors need positive reinforcement to make decisions. We want to be verified by advice and what others are doing.

The end result is an investment decision that is not the result of individual choice. The tulip mania is a classic example of herd mentality. Towards the end of the 16th century, the demand for Dutch tulips skyrocketed. Investors, eyeing a quick buck, flocked in to buy tulip futures. The price of tulips skyrocketed before the bubble finally burst in 1937.

John Huber, manager of the Saber Capital Fund said, “My observation is that independent thought is extremely rate, which makes it valuable… Understanding this reality and being aware of our own human tendencies is probably a necessary condition to investment success in the long run.”

Self-serving bias

The self-serving bias is a common cognitive bias that distorts an investor’s thinking. In essence, the self-serving bias leads us to credit ourselves for successes but blame failures on other causes.

This delusion perpetuates poor investing decisions and limits our ability to learn. Not knowing what you don’t know is probably the single most dangerous flaw in investing.

The best defense against this cognitive bias is to review each investment decision and see if your investment thesis had played out in the first place. Were your investment successes built around solid fundamental reasoning or was it pure luck?

Keeping an investing journal can help us keep track and review our investing decisions.

The Good Investors’ Conclusion

Billionaire hedge fund manager, Seth Klarman, once observed:

“So if the entire country became security analysts, memorized Ben Graham’s Intelligent Investor, and regularly attended Warren Buffett’s annual shareholder meetings, most people would, nevertheless, find themselves irresistibly drawn to hot initial public offerings, momentum strategies, and investment fads.

Even if they somehow managed to be long-term value investors with a portion of their capital, people would still find it tempting to day-trade and perform technical analysis of stock charts. People would, in short, still be attracted to short-term, get-rich-quick schemes.”

Being rational is easier said than done. We humans are built in a way that has helped us survive for thousands of years by making decisions based on fear and greed. So going against these human emotions is innately difficult.

But to be good investors, we need to appreciate and overcome these human emotions and biases. By overcoming our emotions and biases in investing, we are more likely to make sound investing decisions that give us the best chance of long-term investing success.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

There are no guarantees in the world of investing… or are there? Here are six things about investing that I’m certain will happen in 2020.

1. There will be something huge to worry about in the financial markets.

Peter Lynch is the legendary manager of the Fidelity Magellan Fund who earned a 29% annual return during his 13-year tenure from 1977 to 1990. He once said:

“There is always something to worry about. Avoid weekend thinking and ignore the latest dire predictions of the newscasters. Sell a stock because the company’s fundamentals deteriorate, not because the sky is falling.”

Imagine a year in which all the following happened: (1) The US enters a recession; (2) the US goes to war in the Middle East; and (3) the price of oil doubles in three months. Scary? Well, there’s no need to imagine: They all happened in 1990. And what about the S&P 500? It has increased by nearly 800% from the start of 1990 to today, even without counting dividends.

There will always be things to worry about. But that doesn’t mean we shouldn’t invest.

2. Individual stocks will be volatile.

From 1997 to 2018, the maximum peak-to-trough decline in each year for Amazon.com’s stock price ranged from 12.6% to 83.0%. In other words, Amazon’s stock price had suffered a double-digit fall every single year. Meanwhile, the same Amazon stock price had climbed by 76,000% (from US$1.96 to more than US$1,500) over the same period.

If you’re investing in individual stocks, be prepared for a wild ride. Volatility is a feature of the stock market – it’s not a sign that things are broken. 

3. The US-China trade war will either remain status quo, intensify, or blow over.

“Seriously!?” I can hear your thoughts. But I’m stating the obvious for a good reason: We should not let our views on geopolitical events dictate our investment actions. Don’t just take my words for it. Warren Buffett himself said so. In his 1994 Berkshire Hathaway shareholders’ letter, Buffett wrote (emphases are mine):

“We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen.

Thirty years ago, no one could have foreseen the huge expansion of the Vietnam War, wage and price controls, two oil shocks, the resignation of a president, the dissolution of the Soviet Union, a one-day drop in the Dow of 508 points, or treasury bill yields fluctuating between 2.8% and 17.4%.

But, surprise – none of these blockbuster events made the slightest dent in Ben Graham’s investment principles. Nor did they render unsound the negotiated purchases of fine businesses at sensible prices.

Imagine the cost to us, then, if we had let a fear of unknowns cause us to defer or alter the deployment of capital. Indeed, we have usually made our best purchases when apprehensions about some macro event were at a peak. Fear is the foe of the faddist, but the friend of the fundamentalist.

A different set of major shocks is sure to occur in the next 30 years. We will neither try to predict these nor to profit from them. If we can identify businesses similar to those we have purchased in the past, external surprises will have little effect on our long-term results.”

From 1994 to 2018, Berkshire Hathaway’s book value per share, a proxy for the company’s value, grew by 13.5% annually. Buffett’s disciplined focus on long-term business fundamentals – while ignoring the distractions of political and economic forecasts – has worked out just fine.

4. Interest rates will move in one of three ways: Sideways, up, or down.

“Again, Captain Obvious!?” Please bear with me. There is a good reason why I’m stating the obvious again.

Much ado has been made about what central banks have been doing, and would do, with their respective economies’ benchmark interest rates. This is because of the theoretical link between interest rates and stock prices.

Stocks and other asset classes (bonds, cash, real estate etc.) are constantly competing for capital. In theory, when interest rates are high, the valuation of stocks should be low, since the alternative to stocks – bonds – are providing a good return. On the other hand, when interest rates are low, the valuation of stocks should be high, since the alternative – again, bonds – are providing a poor return.

But if we’re long-term investors in the stock market, I think we really do not need to pay much attention to what central banks are doing with interest rates.

There’s an amazing free repository of long-term US financial market data that is maintained by Robert Shiller. He is a professor of economics and the winner of a Nobel Prize in economics in 2013. 

His data includes long-term interest rates in the US, as well as US stock market valuations, going back to the 1870s. The S&P 500 index is used as the representation for US stocks while the cyclically adjusted price earnings (CAPE) ratio is the valuation measure. The CAPE ratio divides a stock’s price by its inflation-adjusted average earnings over a 10-year period.

The chart below shows US long-term interest rates and the CAPE ratio of the S&P 500 since 1920:

Contrary to theory, there was a 30-plus year period that started in the early 1930s when interest rates and the S&P 500’s CAPE ratio both grew. It was only in the early 1980s when falling interest rates were met with rising valuations. 

To me, Shiller’s data shows how changes in interest rates alone can’t tell us much about the movement of stocks. In fact, relationships in finance are seldom clear-cut. “If A happens, then B will occur” is rarely seen.

Time that’s spent watching central banks’ decisions regarding interest rates will be better spent studying business fundamentals. The quality of a company’s business and the growth opportunities it has matter far more to its stock price over the long run than interest rates. 

Sears is a case in point. In the 1980s, the US-based company was the dominant retailer in the country. Morgan Housel wrote in his recent blog post, Common Plots of Economic History :

“Sears was the largest retailer in the world, housed in the tallest building in the world, employing one of the largest workforces.

“No one has to tell you you’ve come to the right place. The look of merchandising authority is complete and unmistakable,” The New York Times wrote of Sears in 1983.

Sears was so good at retailing that in the 1970s and ‘80s it ventured into other areas, like finance. It owned Allstate Insurance, Discover credit card, the Dean Witter brokerage for your stocks and Coldwell Banker brokerage for your house.”

US long-term interest rates fell dramatically from around 15% in the early-to-mid 1980s to 3% or so in 2018. But Sears filed for bankruptcy in October 2018, leaving its shareholders with an empty bag. In his blog post mentioned earlier, Housel also wrote:

“Growing income inequality pushed consumers to either bargain or luxury goods, leaving Sears in the shrinking middle. Competition from Wal-Mart and Target – younger and hungrier – took off.

By the late 2000s Sears was a shell of its former self. “YES, WE ARE OPEN” a sign outside my local Sears read – a reminder to customers who had all but written it off.” 

If you’re investing for the long run, there are far more important things to watch than interest rates.

5. There will be investors who are itching to make wholesale changes to their investment portfolios for 2020.

Ofer Azar is a behavioural economist. He once studied more than 300 penalty kicks in professional football (or soccer) games. The goalkeepers who jumped left made a save 14.2% of the time while those who jumped right had a 12.6% success rate. Those who stayed in the centre of the goal saved a penalty 33.3% of the time.

Interestingly, only 6% of the keepers whom Azar studied chose to stay put in the centre. Azar concluded that the keepers’ moves highlight the action bias in us, where we think doing something is better than doing nothing. 

The bias can manifest in investing too, where we develop the urge to do something to our portfolios, especially during periods of volatility. We should guard against the action bias. This is because doing nothing to our portfolios is often better than doing something. I have two great examples. 

The first is a paper published by finance professors Brad Barber and Terry Odean in 2000. They analysed the trading records of more than 66,000 US households over a five-year period from 1991 to 1996. They found that the most frequent traders generated the lowest returns – and the difference is stark. The average household earned 16.4% per year for the timeframe under study but the active traders only made 11.4% per year.

Second, finance professor Jeremy Siegel discovered something fascinating in the mid-2000s. In an interview with Wharton, Siegel said:

“If you bought the original S&P 500 stocks, and held them until today—simple buy and hold, reinvesting dividends—you outpaced the S&P 500 index itself, which adds about 20 new stocks every year and has added almost 1,000 new stocks since its inception in 1957.”

Doing nothing beats doing something. 

6. There are 7.7 billion individuals in the world today, and the vast majority of us will wake up every morning wanting to improve the world and our own lot in life.

This motivation is ultimately what fuels the global economy and financial markets. There are miscreants who appear occasionally to mess things up, but we should have faith in the collective positivity of humankind. We should have faith in us. The idiots’ mess will be temporary.

To me, investing in stocks is the same as having the long-term view that we humans are always striving collectively to improve the world. What about you?

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

John Huber is one of the top-performing fund managers of the decade. His Saber Investment fund has achieved a gross annualised return of 20.66% since 2014. That puts his fund well ahead of the S&P 500 which has annualised at 10.89%.

I spent my weekend studying some of Huber’s letters to shareholders and blog posts. Here are three investing lessons from his writings.

Time is a valuable edge

Fund managers often get asked the question, “what is your edge”? The two main responses that institutional investors look for are some sort of “information” or “analytical” edge.

However, Huber believes that in an era of easily-accessible information, both these edges do not exist anymore. Huber explains:

“I’ve observed over the years that whatever information an investor believes to be unique is almost always understood by many other market participants, and thus is not valuable.

The mispricing is not in the stock itself, but in the investor’s own perception of the value of information: it’s worth far less than they believe it is. Information is now a commodity, and like the unit price of computing power that provides it, the value has steadily fallen as the supply and access to it has skyrocketed.”

But the absence of an “informational” or “analytical” edge does not mean stock pickers cannot outperform the market. Huber believes that the “time horizon” edge is still alive and kicking.

The “time horizon” edge is formed because today’s market participants are more interested in short-term gains over the long-term. Huber notes that many investment firms today make investing decisions based entirely on short-term stock price movements. These decisions have nothing to do with long-term value. 

This creates a huge pricing mismatch between a stock’s long-term value and the current stock price. In turn, it creates a massive opportunity for long-term investors to outperform the market.

But the “time horizon” edge does come with its price. Huber explains:

“The price of gaining this edge is the volatility that could occur in the near term. You have to be willing to accept the possibility that your stock will go down before it goes up. Very few investors are willing to pay that price, which is why even large-cap stocks can become disconnected from their long term fair values.”

Don’t be afraid to say, “I don’t know”

Huber wrote a great article on one of Warren Buffett’s underrated investment attributes: His ability to recognize when a situation is outside of his well-defined circle of competence.

Buffett has been able to do extremely well in the stock market simply by focusing on more-certain bets and resisting everything else.

The ability to say “no” has enabled Buffett to have very few major mistakes on his record.

More impressively, Buffett is also humble enough to admit when he is wrong. For example, his ability to realise his mistakes led him to make smart investment exits in IBM, Tesco, and Freddie Mac. Huber wrote:

“I think the vast majority of investment mistakes can be traced back to the inability to be honest about your own knowledge or level of understanding about a subject matter.

It’s hard for smart people who have spent their lives being right far more often than they are wrong to admit to themselves that something is too challenging.

It is even harder to admit that their original assessment was completely wrong. So I think intellectual honesty can be a source of a powerful edge for those who can harness it to their advantage.”

Individual thought is essential

Huber also explains that one of the biggest risks in investing is allowing others to indirectly make your investment decisions.

Too often investors rely on outside advisors to make an investment decision. But the advice may be based on different economic interests, investment horizons, or goals. 

Investors also tend to copy high-profile investors. However, high-profile investors can also occasionally make mistakes. 

Theranos, one of the most high profile fraud cases of the decade, managed to secure billions in funding before it was eventually found out. Its early investors were some of the most respected business people of our time. They included the likes of Carlos Slim, Robert Kraft, Larry Ellison, Rupert Murdoch, and the Walton family. Huber notes:

“My observation is that independent thought is extremely rare, which makes it very valuable.

On the other hand, outsourced thinking appears to be pervasive in the investment community, and because of how we’re wired, this dynamic is unlikely to change. Regardless of how convincing the facts are, we are just more comfortable if we can mold our opinion around the opinion of others.

Understanding this reality and being aware of our own human tendencies is probably a necessary condition to investment success in the long run.”

Ser Jing and I started The Good Investors as a platform to raise awareness on how investors can invest well for themselves while doing good for the world. These two objectives are by no means mutually exclusive. 

Driving growth

In his book Sapiens: a Brief History of Humankind, Yuval Noah Harari devoted a whole chapter to how capitalism contributed to the modernisation and growth of the world’s economy. He wrote:

“Capitalism distinguishes ‘capital’ from mere ‘wealth’. Capital consists of money, goods, and resources that are invested in production. Wealth, on the other hand, is buried in the ground or wasted on unproductive activities.”

Capitalism is, hence, one of the driving forces of real economic growth over the last five centuries.

But free markets that are solely after profits can be detrimental to society. The slave trade, for example, was the product of free-market capitalism. Harrari wrote, “When growth becomes a supreme good, unrestricted by any other ethical considerations, it can easily lead to catastrophe.”

To prevent this, investors should focus on ethical investing, rather than simply chasing after profits. Investing responsibly can not only fuel economic growth but can also help drive innovation, promote good practices, and reverse climate change, among others.

Investors today are much more conscious of how they can do well while doing good. With that said, I have compiled a list of five ways investors can invest for the greater good.

1. Avoiding sin stocks

Tim Nash, the founder of Good Investing, describes negative screening as doing less evil. By avoiding sin stocks, capital allocators force companies to rethink their strategy and discourage entrepreneurs from moving into the controversial sector in the first place.

Each of us may have a different definition of sin stocks depending on our personal values. However, some commonly cited “sin stocks” include weapons, fossil fuels, and cigarette companies.

2. Investing in green technology

We can also actively invest in companies that are striving to make the world a better place.

Climate change is one of the biggest challenges of the world today. It is, therefore, no surprise that investors are now prioritising green technology more than ever. But the success of green technology can only be achieved if both investors and consumers are willing to back it.

Some examples of green technology include solar power, electric vehicles, water purification, and LED lights. 

Thankfully, it seems that the world is moving in the right direction when it comes to green technology. In November 2019, the Singapore government announced that it will invest US$2 billion in funds that have a strong green focus. 

3. Investing in necessities

In Singapore, we take clean water for granted. However, unsafe sanitation is still a massive problem in Africa. Unsanitary water contributes to more than 1,200 deaths of children under five years old per day.

The Bill & Melinda Gates Foundation has taken massive steps to alleviate the problem, through education and waste treatment technology. 

Investors can contribute too. We can play our part by funneling our capital to companies that are helping to alleviate the sanitisation problem.

Besides water, investors can also consider supporting companies that champion basic human rights, promote education, enable sustainable farming, and others.

4. Innovative companies

Some companies are improving the lives of millions of people simply through innovative technologies.

Take Alphabet Inc, for example. The parent company of Google has increased its focus away from merely “organising information”. Today, the tech conglomerate has investments in healthcare and autonomous vehicles, and even provides the world with faster Internet access through fiber networks.

Many of us also probably also use some of Google’s other applications that make our lives much easier, like Google Maps, Gmail, Google Photos, and even Google Translate.

Alphabet is certainly not the only company making a difference to the world. Today, there are more tech companies than ever that are coming up with innovative solutions that are not only financially feasible but improving the lives of millions.

5. Healthcare

Another way we can invest for the greater good is by investing in healthcare companies. The pharmaceutical sector, for instance, is responsible for the innovation of numerous drugs that have saved the lives of millions.

However, pharmaceutical companies require bucketloads of cash to fund research and clinical trials.

While the biggest pharmaceutical companies are self-sustainable through the money earned from earlier blockbuster drugs, many are still in their infant stages. Such firms are desperately in need of capital.

Investors can help to fund research by investing in these companies. There is also the potential of profit should one of the pipeline drugs get commercialised.

Doing well while doing good

Contrary to popular belief, investing need not be solely for enriching yourself. By selectively investing in companies that are doing good for the world, we not only stand to profit but can also improve the world in the process.

My hope is that more investors use their capital not only as a means to enrich themselves but also for the greater good of the world.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.