I was browsing on the First State Stuart Asia website, and found some interesting 'insights'...
1. The power of compounding.
Compounding works when returns are reinvested to generate further returns. Well, to put it this way, if you generate a compounded return of 7% for ten years you can double the amount of money you have. Now, if you are also adding more capital to the portfolio on a yearly basis, within a 75 year lifespan, you can work miracles.
... and decided to make note of some of the different influencing factors all aspiring investors should be aware of. It is not possible to prevent the 'biases' referred to below from clouding our judgement, but by being aware of them, we can limit the cloudiness.
2. The 'knew it all along' effect, hindsight bias, and embracing uncertainty.
This is also known as hindsight bias. Things always seem a lot more obvious in hindsight. This is because forecasting is inherently speculative; it is meant to be uncertain. Always remember that ANYTHING CAN HAPPEN; just because its unlikely, that doesn't mean its impossible.
Hindsight bias can be particularly dangerous if your investment goes well. This may result in you being overconfident, and could result in you overlooking potential outcomes. Just because you were right once, doesn't mean you are a good investor! Indeed, sometimes your 'winners' may have been successful for reasons very different to the reasons for which you invested in that company. When this happens, make sure to compare your predictions with the way in which things turned out. Indeed, all forecasts have 'buts' and 'ifs', and are telling you more about the forecaster than the future.
3. Disposition effect, Self-Attribution and Denial, and Neglect and Breaking even.
i. Disposition effect.
This is the human tendency to sell winners prematurely, thinking that the top has been reached, and the tendency to cling on to poor investments. Remember, no one knows exactly what will occur; those who say they do, are probably deluded, lying or from the future! Its simple (not)! One option, and arguably a great one, is to pick good companies, and remain an investor for as long as possible.
ii. Self-attribution and Denial.
It is very tempting to claim credit when an investment goes well, and blame luck when things go awry. But, sometimes your 'winners' may have been successful for reasons very different to the reasons for which you invested in that company. Moreover, as Phil Knight says, "The harder you work, the better your Tao". Overall, on an average measured over 70 years, results will probably be dictated by your efforts rather than your luck. Thus, it would be stupid just to blame bad luck and not recognise losers as material losses. The ideal would be to relish mistakes and successes equally, and to learn from them. Its worth asking 'what went wrong'. At the same time, forgetting that luck was involved in your success (and failure), would be bad too.
iii. Neglect and Breaking even.
People are more interested in investments which are doing well, and tend to neglect underperforming companies in their portfolio. This is ridiculous. When something is not going as you expected it to, you must attempt to understand why. If you do not try to understand why the share price has reduced, you will be unable to notice if there has been a significant change in the business' underlying economics.
You must be willing to acknowledge a failure, if facts invalidate your investment thesis, and not wait for the price to rise up to the purchase price, as there is no assurance that it will. At the same time, if the share price goes down, it doesn't mean the company is necessarily bad, and reacting to movements in share price would be counterproductive.
4. Herd Behaviour
This is essentially a large number of people acting in the same way collectively. This often manifests itself in bubble thinking; people buy when the market is going up, and sell when the market corrects. The latter usually occurs when people realise (in hindsight), that a bubble had indeed formed. Herd Behaviour is driven by emotion, and is irrational. This is because if you really want to make money on the stock market, you have to be greedy when others are fearful and fearful when others are greedy. To paraphrase Howard Marks, you must be willing to catch a falling knife.
Bubble indicators - what to watch out for
Strong, sustained rallies and stretched valuations (High P/E multiples for example)
Hearing “this time it’s different” (This occurs when people are not being diligent when making decisions)
A flurry of initial public offerings, mergers and acquisitions (People, do more IPOs because valuations are high)
Investor greed and a fear of missing out (FOMO)
Everything moving together, regardless of quality
Media headlines talking up the latest investment trend
Bibliography
1.http://www.firststateinvestments.com/sg/en/retail/Insights/Behavioural_Investing_Paper_1__The_Power_of_Compounding/
2.http://www.firststateinvestments.com/sg/en/retail/Insights/Behavioural_Investing_Paper_2__Hindsight_Bias/
3.http://www.firststateinvestments.com/sg/en/retail/Insights/Behavioural_Investing_Paper_3__Disposition_Effect/
4.http://www.firststatestewartasia.com/sg/en/retail/Insights/Behavioural_Investing_Paper_4__Herd_behaviour/
1. The power of compounding.
Compounding works when returns are reinvested to generate further returns. Well, to put it this way, if you generate a compounded return of 7% for ten years you can double the amount of money you have. Now, if you are also adding more capital to the portfolio on a yearly basis, within a 75 year lifespan, you can work miracles.
... and decided to make note of some of the different influencing factors all aspiring investors should be aware of. It is not possible to prevent the 'biases' referred to below from clouding our judgement, but by being aware of them, we can limit the cloudiness.
2. The 'knew it all along' effect, hindsight bias, and embracing uncertainty.
This is also known as hindsight bias. Things always seem a lot more obvious in hindsight. This is because forecasting is inherently speculative; it is meant to be uncertain. Always remember that ANYTHING CAN HAPPEN; just because its unlikely, that doesn't mean its impossible.
Hindsight bias can be particularly dangerous if your investment goes well. This may result in you being overconfident, and could result in you overlooking potential outcomes. Just because you were right once, doesn't mean you are a good investor! Indeed, sometimes your 'winners' may have been successful for reasons very different to the reasons for which you invested in that company. When this happens, make sure to compare your predictions with the way in which things turned out. Indeed, all forecasts have 'buts' and 'ifs', and are telling you more about the forecaster than the future.
3. Disposition effect, Self-Attribution and Denial, and Neglect and Breaking even.
i. Disposition effect.
This is the human tendency to sell winners prematurely, thinking that the top has been reached, and the tendency to cling on to poor investments. Remember, no one knows exactly what will occur; those who say they do, are probably deluded, lying or from the future! Its simple (not)! One option, and arguably a great one, is to pick good companies, and remain an investor for as long as possible.
ii. Self-attribution and Denial.
It is very tempting to claim credit when an investment goes well, and blame luck when things go awry. But, sometimes your 'winners' may have been successful for reasons very different to the reasons for which you invested in that company. Moreover, as Phil Knight says, "The harder you work, the better your Tao". Overall, on an average measured over 70 years, results will probably be dictated by your efforts rather than your luck. Thus, it would be stupid just to blame bad luck and not recognise losers as material losses. The ideal would be to relish mistakes and successes equally, and to learn from them. Its worth asking 'what went wrong'. At the same time, forgetting that luck was involved in your success (and failure), would be bad too.
iii. Neglect and Breaking even.
People are more interested in investments which are doing well, and tend to neglect underperforming companies in their portfolio. This is ridiculous. When something is not going as you expected it to, you must attempt to understand why. If you do not try to understand why the share price has reduced, you will be unable to notice if there has been a significant change in the business' underlying economics.
You must be willing to acknowledge a failure, if facts invalidate your investment thesis, and not wait for the price to rise up to the purchase price, as there is no assurance that it will. At the same time, if the share price goes down, it doesn't mean the company is necessarily bad, and reacting to movements in share price would be counterproductive.
4. Herd Behaviour
This is essentially a large number of people acting in the same way collectively. This often manifests itself in bubble thinking; people buy when the market is going up, and sell when the market corrects. The latter usually occurs when people realise (in hindsight), that a bubble had indeed formed. Herd Behaviour is driven by emotion, and is irrational. This is because if you really want to make money on the stock market, you have to be greedy when others are fearful and fearful when others are greedy. To paraphrase Howard Marks, you must be willing to catch a falling knife.
Bubble indicators - what to watch out for
Bibliography
1.http://www.firststateinvestments.com/sg/en/retail/Insights/Behavioural_Investing_Paper_1__The_Power_of_Compounding/
2.http://www.firststateinvestments.com/sg/en/retail/Insights/Behavioural_Investing_Paper_2__Hindsight_Bias/
3.http://www.firststateinvestments.com/sg/en/retail/Insights/Behavioural_Investing_Paper_3__Disposition_Effect/
4.http://www.firststatestewartasia.com/sg/en/retail/Insights/Behavioural_Investing_Paper_4__Herd_behaviour/
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