Saturday 1 June 2013

The Biggest Mistake An Investor Can Make

This is the worst mistake you're probably making -- and here's how to fix it.

You're probably making the worst mistake an investor can make. I know I am. And after the bull run we've been enjoying, that mistake probably got a lot worse.

The French author André Maurois once said: "Everything that is in agreement with our personal desires seems true. Everything that is not puts us into a rage."

That's the mistake. "Rage" may be far too strong a word for most of us. But you'll see plenty rage around the investment discussion forums on the web -- particularly when someone presents a sensible bear case for an individual stock.

Maurois also said: "We appreciate frankness from those who like us. Frankness from others is called insolence." And therein lies the key to overcoming this mistake.

One big mistake -- lots of names
The mistake is in deciding that an investment is great for whatever reasons, then closing oneself off to alternative viewpoints. Some call it "falling in love" with a share, whilst the behavioural economists refer to it as confirmation bias; is the tendency of people to favour information that confirms their beliefs or hypotheses.

It's closely related to other ways to lose money on shares such as anchoring, overconfidence and availability bias (the tendency to give undue weight to more prominent facts).

I'd say it's also related to what Peter Lynch describes as the greatest single fallacy of investing; the feeling of being "right" when your shares have risen.

"If I had to choose a great single fallacy of investing, it's believing that when a stock's price goes up, then you've made a good investment," says Lynch.

In short, we really want to be right -- and we really don't give fair weight to the opposing viewpoints. And if anyone but a friend presents the opposing viewpoint to us, we don't like it one bit. It's an innate part of our psychology. But it's still a mistake.

How to beat it
So how do you overcome it?

Undoubtedly the most difficult thing is to set aside one's emotions. This is easy to say but harder to do. But if we can gather facts in an impartial and objective way, and weigh them well; then it has to be a good thing for investing.

There are a few useful tactics you can use to achieve this:
* One is to pretend you're collecting the bullish and bearish points to present to other people to let them decide for themselves in a balanced way.

* Another is to explain to a true friend who understands a little about the market why you think as you do -- and to let him/her punch a few holes in your case.

* A third way is to try to present only the opposite side of the case -- as would a barrister, for example, in trying to paint an opposing picture. It's surprising how often this one cools your ardour.

* And finally -- do try the discussion boards with your reasoned analysis, but promise you'll be without "rage" whatever flak your ideas attract.

Do something
But eventually there comes a time to act. When you've done all the analysis you can, and weighed the pros and cons; then act on your information. Dither no longer. Either buy, sell, or walk away without regret whatever happens next.

You decided what you decided in the best and most objective way you could with as much factual information at your disposal as you could muster. That's it. Que sera, sera. There's a time to act and not to look back.

If you're proven to have been right -- great. But judge your decisions on a reasonable timescale and don't be fooled into thinking you were right by virtue of macro market direction alone.

Short-term fluctuations mean nothing. If you were wrong and are looking at the same investment again down the line -- then it's a new day.

What was done, was done. So the process needs to be repeated in light of new evidence or at least a revised valuation.

By David Holding
http://www.fool.co.uk

No comments: