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Four Most Important Emotional Biases in investing kcchongnz
In my previous article on “Stock Market Investing strategy: Buying good companies” in the link below,
https://klse.i3investor.com/blogs/kcchongnz/161473.jsp
I was advocating that when one invests in a stock, he must treat it as investing in part of a business, rather than taking it as buying a piece of paper (share certificate) and shuffling it around to get a quick buck.
I have discussed in the above article that if one wish to build long-term wealth, he should first buy the stock of a good business. I have deliberated what a good business is about with the following characteristics,
- The business must be durable and be able to last for a long time to come
- It has a record of stability of earnings and cash flows
- It earns return higher than the cost of its capitals to be shareholder value enhancing, otherwise why do the business, or buy the stock? Unless it is selling dirt cheap.
- It has a good growth prospect, with the business expanding and earning more money in the future.
- It should have a healthy balance sheet and not overly geared so that it can withstand bankruptcy risks during economic and financial crisis.
- It must have a smart and capable, forward looking, credible and honest management who would take care business well as well as the interest of minority shareholders.
- Other attributes of a good business
Following the above article, I argued in the next article, “The Most Important Thing in Investing: Price versus Value” in the link below that buying a good company doesn’t mean one will be successful in investing. It has to depend on the price you pay for the piece of business.
https://klse.i3investor.com/blogs/kcchongnz/162226.jsp
I have also deliberated a number of valuation techniques, their advantages and pitfalls in the link above.
“Investment success doesn’t come from “buying good things,” but rather from “buying things well.”” Harvard Marks
What else does an investor need to know in order to be successful in investing? BS?
Yes, Business sense (BS1) is important, absolutely. But hasn’t business sense covered in the above; buying a good business when it is selling cheap? Of course, “business sense” has been fully covered in details above. But definitely not the other BS, BS2, or more specifically “Bullshitting”.
Then what else is required to be successful in investing? Definitely there is something else which is very important, or else those professional analysts, investment bankers who are mostly with MBA or PHDs in accounting, finance and investing would be the riches people in the world.
I am arguing that the other very important attribute of a successful investor is the understanding of behavioural finance and utilize it to maximise investment returns.
This is because in reality, investors do not only deal with facts but with also affected by emotions, fear and greed and others which would be discussed in details below. Hence, understanding the cognitive biases investors have, one who also has the facts may profit from the irrational behaviour of the investors.
Some emotional biases in investing
Here are the 4 most important emotional biases and how they affect us.
- Loss-Aversion bias: When people tend to strongly prefer avoiding losses as opposed to achieving gains. Studies suggest that psychologically, losses are significantly more powerful than gains. When comparing absolute values, the utility derived from a gain is much lower than the utility given up with an equivalent loss.
When investor opens the monthly account statement and scans for winners and losers. Usually, the investor holds on to the losers until they break even, while selling the winners to realize gains and avoid further risks.
Some highly risk averse investors also tend to over diversify with tenths of stocks, or even over hundred of stocks in their portfolio to reduce risk. As a result, the outcome of their return would likely to be average.
- Overconfidence bias: This bias takes place when people demonstrate faith in their own intuitive reasoning, judgments and/or cognitive abilities. That could be the result of previous occasional success, which could be due to some kind of luck. This may result in overestimating knowledge levels, abilities and access to information.
Some investors equate the quantity of information with its quality, which causes underestimation of risks and overestimation of expected returns. Even worse, some purely base on some over-simplistic “Rule” and apply it to all situations. Worse still, they combine their over-confidence with ignorance and heavy leverage.
For the past few months, there were so many people falling into this predicament, with margin calls and heavy losses in the stock market as the market tanked.
“It is not an algorithm. It is a mindset. I think that we always try to stress the danger of overconfidence. I forget if I put it in the book, but it is better if you invest scared, if you worry about losing money, if you worry about being wrong, if you worry about being overconfident because these are the things you want to avoid. They should be foremost in your mind. The most dangerous thing is to think you got it figured out, or that you can’t make a mistake, or that your estimates are right because they are yours. You have to always recheck your information, bounce your ideas off of yourself and others.” Howard Marks
- Self-control bias: When people fail to act in pursuit of their long-term goals because of a lack of self-discipline.
Most players in the stock market following tips, rumours, hypes and persuasion from those people they know, and those they respect, and buy stocks touted by them, hoping to become rich fast from short term gains. Some even follow the calls of using margin for “sure” and speculated for fast gains. Why not? Those they respect and trust have told them how they have become filthy rich by following certain simplistic “rule” with heavy margin in the stock market.
Sadly, few are patience enough to invest safely following the “right path” to build up long-term wealth, safely and surely. But that is the norm in the market.
“Spend each day trying to be a little wiser than you were when you woke up. Discharge your duties faithfully and well. Step by step you get ahead, but not necessarily in fast spurts. But you build discipline by preparing for fast spurts. Slug it out one inch at a time, day by day. At the end of the day – if you live long enough – most people get what they deserve.” Charlie Munger
- Regret-aversion bias: When people tend to avoid making decisions that will result in action out of fear that the decision will turn out poorly.
Many people bought into stocks which they have no idea about their business, and most of them have been bad business with poor management. Scores of them in the portfolio and never take any action with most of them losing heavily over the years while the market has been going up. No action becomes their preferred decision as selling bad business would have realized losses. This happens when we take a very conservative stance fearing poor outcomes, or when we just follow the herd.
“Have the courage of your knowledge and experience. If you have formed a conclusion from the facts and if you know your judgment is sound, act on it - even though others may hesitate or differ. You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.” Benjamin Graham
Search for good business and invest for long-term when they are selling cheap certainly will result in good investment outcome. Why not? The reasons are plausible.
Understand the behavioural biases and act on them would likely to further improve your investment outcome. For example, never be over-confidence to avoid huge losses in the stock market; Sell off those lemons in your portfolio to counter Regret-aversion bias, to be able to control yourself for long-term goal rather than short-term gains, do not over diversified in order for extra-ordinary gains, but remember, do not be over-confidence by dumping everything in two or three stocks only, etc.
KC Chong (ckc14invest@gmail.com)
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Discussions
1 person likes this. Showing 16 of 16 comments
you want to be a value investor and want to be a business partner in the invested company..?...
too bad.....this gives rise to an irreconcilable conundrum.
let me explain
this kc and this i3 is filled to the brim with fake value investors.....but what is value, by the way, in the context of stock market?
value is in the eye of the beholder, its a matter of perception, of trends and what is fashionable, ....most definitely not a maths formula.
What is value? Where does it come from? A psychological perspective
http://www.oxfordscholarship.com/view/10.1093/acprof:oso/9780198716600...-3
value investors like to give you the analogy of a bargain....everyone loves a good bargain....everyone wishes he can get $ 1 value for a 50 sen payment.........in the stock market, its an illusion.....because while your 50 sen payment is real enough, the $ 1 value in your mind is all an illusion.......its not real. Its just some thing in your mind. .......and you will be tested soon enough ............
of course, if you look at a proposition as a business proposition, some thing you like to have, some thing you like to be associated with, some thing that identifies you as a person, an identity, an expertise, an interest, .........the relationship can last longer, not so stressful, you don't need to be so stressed up..........and this is the attitude of fund managers when they invest long term in a share.
the conundrum of retail investors who call themselves value investors is real. Very real. It challenges them every time they look at the share market.
value investors? my foot. .......the market moves against you, you will know whether you are value investor or not......value is not as chipped in stone as you think.
the share market is a game...a game people plays.....
Be proud to be a trader / speculator.
https://klse.i3investor.com/blogs/qqq3/151380.jsp
Fund managers manages a portfolio....they have deep knowledge of portfolio theories and don't feast or famine based on the values of this or that share and next quarter report........
stock market....every era got new heroes, and got people who wants to sell you their services.
as for me.......I think people are smart, ...and they can built their confidence through experience...and the last thing you need is to surrender to people who hang pig head to sell dog meat....Everyone needs to eventually develop his or her own style.
whatever the situation, whatever the circumstances, remisiers and gurus will want to sell you their services.....that is no good.
2018-07-24 01:15
value investor? intrinsic value? target price? contrarian investing?
its an illusion....all an illusion.
https://klse.i3investor.com/blogs/qqq3/165703.jsp
2018-07-24 03:58
Posted by qqq3 > Jul 24, 2018 01:15 AM | Report Abuse
value is in the eye of the beholder, its a matter of perception, of trends and what is fashionable, ....most definitely not a maths formula.
value investors? my foot. .......the market moves against you, you will know whether you are value investor or not......value is not as chipped in stone as you think.
the share market is a game...a game people plays.....
Be proud to be a trader / speculator.
Still never wonder why some people after working for decades, retire and still do no have RM100k to invest? How are they going to live for the next 20 years?
Whereas many value investors have compounded their money, retire, traveling here and there, playing golf, without worrying about money running out before they expire.
You have again said it all in your above comments.
2018-07-24 07:22
kc
how is it that you need to cari makan from i3 members and I don't need to?
in fact, not only that....I don't need to work for more than 20 years already......and I have been travelling and playing golf for more than 20 years already.....and in another 20 years, my margin account will be as big as KYY when he is 80.
2018-07-24 08:03
y kcchongnz > Jul 24, 2018 07:22 AM | Report Abuse
Whereas many value investors have compounded their money,....
=============
kc
compounding money is fixed rate instruments and portfolio managers with their portfolio theories.
businessman approach to equities.....and here is excellent example.......its business sense, business instincts....not maths formulas....
http://klse.i3investor.com/blogs/koonyewyinblog/166599.jsp
compounding money in stock market for retail investors is an illusion.
bull market make money, bear market lose money is not called compounding......it is risk- reward.....and timing.
2018-07-24 14:34
Posted by kcchongnz > Jul 24, 2018 03:18 PM | Report Abuse X
Posted by qqq3 > Jul 24, 2018 02:34 PM | Report Abuse
kc
compounding money is fixed rate instruments and portfolio managers with their portfolio theories.
ME: WHAT, COMPOUNDING MONEY IS FIXED RATE INSTRUMENT?
"What is 'Compounding'
Compounding is the process in which an asset's earnings, from either capital gains or interest, are reinvested to generate additional earnings over time. This growth, calculated using exponential functions, occurs because the investment will generate earnings from both its initial principal and the accumulated earnings from preceding periods. Compounding, therefore, differs from linear growth, where only the principal earns interest each period."
WHERE DOES IT REFER TO FIXED RATE INSTRUMENTS? WHAT IS IT TO DO WITH PORTFOLIO MANAGER? WHAT IS IT TO DO WITH PORTFOLIO THEORIES? WHAT THEORIES?
YOU ARE CONTINUOUSLY EXPOSING YOUR BACKSIDE. NO SHAME MEH?
businessman approach to equities.....and here is excellent example.......its business sense, business instincts....not maths formulas....
http://klse.i3investor.com/blogs/koonyewyinblog/166599.jsp
ME: BUSINESS SENSE? SAILANG?
WHAT WOULD HAPPEN TO YOU IF YOU SAILANG WITH MARGIN FINANCE BUYING JAKS UP TO RM1.85 AND PLUNGED BY 37% TO RM1.16 NOW?
SAILANG AGAIN? MARGIN FINANCE AGAIN PROPAGATED?
PLEASE BE MORE RESPONSIBLE AS A WELL RESPECTED PERSON IN THE SOCIETY.
BUSINESS SENSE, BUSINESS INSTINCT? NO COMMENT
compounding money in stock market for retail investors is an illusion.
bull market make money, bear market lose money is not called compounding......it is risk- reward.....and timing.
ME: TRY HARD TO UNDERSTAND WHAT COMPOUNDING IS INSTEAD F EXPOSING YOUR IGNORANCE AGAIN AND AGAIN.
2018-07-24 15:35
Posted by qqq3 > Jul 24, 2018 08:03 AM | Report Abuse
kc
how is it that you need to cari makan from i3 members and I don't need to?
ME: ME CARI MAKAN, AND YOU TRAVELING PLAYING GOLF MORE THAN 20 YEARS ALREADY?
WELL, YOU WON'T UNDERSTAND THE JOY OF EDUCATING THE PUBLIC IN USEFUL THINGS, MOST OF THE TIME FOR FREE, DO YOU?
in fact, not only that....I don't need to work for more than 20 years already......and I have been travelling and playing golf for more than 20 years already.....and in another 20 years, my margin account will be as big as KYY when he is 80.
ME: I REALLY DON'T UNDERSTAND HOW SOMEONE AFTER RETIRING DOES NOT EVEN HAVE RM100K TO INVEST IN THE STOCK MARKET, AND STILL HOPE TO BE RICH, LIKE HAVING RM200M IN MARGIN FINANCE.
THAT MEANS YOU MUST MADE RM200M IN 15 YEARS TIME. AND WITH SAY A MAXIMUM OF RM100K NOW TO INVEST, HOW MUCH TO COMPOUND EACH YEAR TO ACHIEVE THAT.
LEARN SOMETHING TO WORK IT OUT. LEARN ABOUT COMPOUNDING. THERE ARE PLENTY OF RESOURCES OUT THERE.
2018-07-24 15:48
you want to be a value investor and want to be a business partner in the invested company..?...
too bad.....this gives rise to an irreconcilable conundrum.
let me explain
maybe I didn't explain clearly enough.....your article talks about value investing and investing as a business and also about emotions.....
value investing.....fair enough, what ever you want....
investing as a business....fair enough , what ever you want.....
Taken separately, fair enough, what ever you want....
taken together.....it creates a conundrum , an irreconcilable conundrum.....emotions will crop in.....emotions crop in because value is an illusion.....value is in the eye of the beholder, its a matter of perception, of trends and what is fashionable, ....most definitely not a maths formula.
investing as a businessman (like kyy).....where got emotion? no emotions.......
value investors? emotions will kill you. ...if your mistaken values don't kill you first.
value investors? lose money still don't know why lose money.
2018-07-24 15:51
SIGH, YOU REALLY ARE THE MOST MONG CHA CHA ACCOUNTANT" I HAVE EVER MET.
AND STILL DON'T EVEN KNOW WHY SOME PEOPLE AFTER WORKING FOR DECADES AND STILL DO NOT HAVE RM100K TO INVEST IN THE STOCK MARKET.
GO SIT DOWN AND MEDITATE UNDER A PUTI TREE AND THINK ABOUT IT.
IF YOU CONTINUOUSLY WASTING YOUR TIME IN I3INVESTOR TALKING NONSENSE LIKE THIS, NOT TO SAY GOING TO HAVE RM200M MARGIN IN 15 YEARS TIME, I AM WORRIED IF YOUR MONEY LEFT CAN LAST FOR EVEN 2 YEARS.
Posted by qqq3 > Jul 24, 2018 03:51 PM | Report Abuse
you want to be a value investor and want to be a business partner in the invested company..?...
too bad.....this gives rise to an irreconcilable conundrum.
let me explain
maybe I didn't explain clearly enough.....your article talks about value investing and investing as a business and also about emotions.....
value investing.....fair enough, what ever you want....
investing as a business....fair enough , what ever you want.....
Taken separately, fair enough, what ever you want....
taken together.....it creates a conundrum , an irreconcilable conundrum.....emotions will crop in.....emotions crop in because value is an illusion.....value is in the eye of the beholder, its a matter of perception, of trends and what is fashionable, ....most definitely not a maths formula.
investing as a businessman (like kyy).....where got emotion? no emotions.......
value investors? emotions will kill you. ...if your mistaken values don't kill you first.
value investors? lose money still don't know why lose money.
2018-07-24 16:04
kcchongnz > Jul 24, 2018 03:48 PM | Report Abuse
THAT MEANS YOU MUST MADE RM200M IN 15 YEARS TIME. AND WITH SAY A MAXIMUM OF RM100K NOW TO INVEST, HOW MUCH TO COMPOUND EACH YEAR TO ACHIEVE THAT.
kc
share market....any thing is possible....its about how much risk I want to take, and about timing.....My $100,000 portfolio of 18 months ago is now $ 300,000 at market value..........what is the compound value in 20 years...? you work out for me.....
2018-07-24 16:33
Posted by qqq3 > Jul 24, 2018 04:33 PM | Report Abuse
kcchongnz > Jul 24, 2018 03:48 PM | Report Abuse
kc
share market....any thing is possible....its about how much risk I want to take, and about timing.....My $100,000 portfolio of 18 months ago is now $ 300,000 at market value..........what is the compound value in 20 years...? you work out for me.....
OKAY OKAY. SINCE AN ACCOUNTANT DOESN'T KNOW HOW TO COMPUTE, AN ENGINEER IS WILLING TO HELP YOU. NO PROBLEM. SAP SAP SUI ONLY.
BUT FIRST SHOW ME THE PORTFOLIO YOU HAVE 18 MONTHS AGO. WHERE HAD YOU PUBLISH IT? WHAT STOCKS YOU HAD, THEIR PRICES ETC.
I PROMISED YOU I WILL HAVE YOU TO WORK OUT THE CAGR WITH THE ABOVE.
2018-07-24 16:43
Engineer is better off exercising his business sense than treating stock market like an engineering problem, a problem known as Physics envy by various authors.......
2018-07-24 18:31
Same psychological conundrum in llife and love.....besides investment
......those 4
2018-07-24 18:34
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2018-07-23 20:26