Financial Education | 22 March, 2018

The investor’s chief problem

Raúl Rendon Portfolio Manager

“The investor’s chief problem, and even his worst enemy, is likely to be himself”

This phrase of Benjamin Graham (considered to be the father of ‘value investing’, is without a doubt what has stuck with me for a long time and that I try to remember often.

It is a very interesting statement and leads us to ask, what determines the return of an investor? I have found numerous responses that tend to be complex, however, usually one of the most important, from my point of view, is not always included in the options. One of the most significant factors is ‘human behaviour’.

For decades economic theory has put forth the idea that man is rational and can maximise his profit in an act of self interest, however, the theories of behavioural finance have documented the specific characteristics of economic behaviour that contravene traditional theory. As mentioned in our previous article, it is difficult to control one’s feelings when investing, because as humans we are susceptible to certain trends, and unconsciously influenced by the stories and thoughts of others, adopting them as our own.

Dr. Daniel Crosby, in his book entitled “The Laws of Wealth”, mentions that economists and psychologists have identified 117 biases capable of obscuring lucid financial decision-making, in other words, there are many ways of making mistakes as a result of our personal biases; and it is difficult to accept, but the majority of us tend to be impatient and arrogant, the latter of which prevents us from achieving our financial goals.

Our trend towards pride is the source of cognitive errors, including the thought of exceptional knowledge that leads to excessive confidence; and this conditioning factor is what most likely explains why investors take concentrated positions, thinking that they have everything under control, and what about those investments in assets with high valuation ratios, where investors believe that they will be able to sell right before the price drops.

It is still interesting that excessive confidence caused people to purchase during the bubbles, i.e. the technological bubble, the real estate bubble.

And what about the people investing in Bitcoin at the end of last year, where they lost at least half their investment?

Are we good enough to invest?

 

Although errors in investments are reflected in the end result, I believe that the errors are made during the initial stages of the investment process, and we should start by taking decisions in a disciplined manner in order to reach our financial goals. Nassim Taleb mentions that “A mistake is not something to be determined after the fact, but in light of the information available until that point”.

Admit our own shortcomings and accept that following the rules is the best way to handle oneself and one’s wealth; in this sense, if self-control and discipline are the best indicators of return, our willingness to ask for help (in this case, a financial advisor) should be a good conditioning factor for successful investments.