On your nerves – part 3
By this point you may have noticed that I have a soft spot for how psychology affects investment decisions. This is well founded, because the more you know about behavioural biases, the more you can limit how your blind-spots impact your investments.
We’ve previously discussed: anchoring, endowment and confirmation biases; as well as: hindsight bias, familiarity, and the gambler’s fallacy. Today we introduce Contra-positive Carrie, Herding Hector and Prospective Pat.
Contra-positive Carrie
Bio: In the popular TV show “Sex and the City”, Carrie Bradshaw spends much of the series pondering her past dating experiences with Mr. Big, she lets this affect her future decisions with him. In the same way, investing Carrie let’s prior stock-specific experiences affect her future re-investment to an investment partner.
Weapons: Carrie remembers buying into Mr. Big at $10 and riding it down to $5. She remembers being wrong and being hurt. This is true even when Mr. Big improves his competitive position, grows his moat and is trading down below fair value. Carrie has an emotional bias, and the fear of being wrong again.
Defence: In investing, it’s important to separate emotions from rational thinking. Look at valuation, not previous outcomes, this lets you re-assess the investment with fresh eyes. This is particularly important when the earnings mix of a company changes.
Herding Hector
Bio: Hector’s not quite a trend setter, but boy does he know what the latest trend is. He’s so into the hottest trends that he blends right into the crowd.
Weapons: Hector will get you excited about all the stocks that are going up. Problem is, he’s not a trend setter and but rather follows the popular crowd. He’ll buy things that are already expensive, and sell again when they’re cheap.
Defence: Being agreeable may buy you some momentum, but it won’t let you generate alpha like an outlier. Look at value, not what your neighbour is doing. Stocks can trade above true value for some time, that doesn’t mean you want to be on board when they come jumping off a bridge.
Prospective Pat
Bio: Pat is risk averse. He’s a bit of a hoarder and more focussed on protecting what’s his than increasing what he owns.
Weapons: Pat gives you grief if you lose $5, but barely flinches if you earn $10. He’s risk averse, to the point of being irrational.
Defence: Taking no risks at all won’t grow your net wealth. Investing involves risk, and the best way to maximise returns is to be rational on the outcome. You can’t win every time, but you can position the probability of outcomes to be in your favour.
The more you know, the more you can be aware of, and control these influences.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
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