This is about the book I read this year “The Little Book of Behavioural Investing”. I found this book interesting as this book helps me recognize some of the behavioral weaknesses and guides how to overcome them. It is important to acquire self-discipline and control over our emotions.
Traditional economics rests on the premise that human beings are perfectly rational creatures who act in their best interests. But in reality, many of us often allow our emotions to prevail and conduct in ways that are not logical. We make decisions that are not necessarily in our best interest. Not only are we behaviourally flawed, says Montier, but we also compound our troubles by failing to recognize our weaknesses. The author suggests that we can avoid being swayed by emotions at critical junctures to re-commit ourselves to the rational course.
I also liked the fact that it is important to focus on the process and not on the outcome. As rightly pointed in the book, the management of returns is impossible and management of risk is illusory, but the process is one thing we can exert an influence over. By focusing on the process we maximize our potential to generate good long-term returns. Not just in investing, humans have an innate tendency to over-rate their skills in most walks of life. We also attribute our successes to our skills and failures to bad luck. If we make money during a bull run, we attribute it to our talents rather than to market conditions. Puffed up with hubris, we then turn careless and buy stocks of poor quality. When the downturn comes, the values of these stocks sink, leaving us emotionally scarred. I committed a similar mistake by investing in one of the transmission companies. In this particular investment, the company kept adding to the order book, posted healthy operating profit but cash flows were poor, resulting in a collapse in profits later on. To avoid such over-confidence, we should deliberately cultivate the habits of being critical and skeptical.
Another area this book touches is information overload, which could be an issue for many professional fund managers in today’s world. In reality, more information could raise our confidence but not necessarily improve the quality of decision-making. Therefore to avoid this overload we must create a simple checklist of 5 to 10 criteria for investing in stocks. This checklist not only gives us a summary of past performance but also helps us differentiate the narrative from execution history. Humans/Investors are also subject to confirmatory bias, wherein we look for evidence/information that confirms the idea that we already have. To overcome this bias it is important that we deliberately seek out views that are at variance with our own and then test the robustness of our views against this newfound opinion.
There is no guarantee that we will become a better investors by reading about investor psychology and issues. Because of these psychological pitfalls, biases are hard-wired in our brains due to our genes or past circumstances. In that sense the job of avoiding these issues is tough. But good awareness and knowledge of the existence of such psychological issues is, in my opinion, the first step towards improvement.
I would recommend investors read this book. This book is full of suggestions and real-life cases of great investors regarding how one can safeguard self against some of these biases.
– Repost from UTI Mutual Fund