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Investing: Watch what you believe

Sep 14, 2009

Views are the lifeblood of investing. Whether they are general principles like 'xyz approach to investing works' or specific calls like, 'abc stock is a good buy at these levels'. Interestingly, people tend to hold very strong views. In fact, it is said, "A man convinced against his will; is of the same opinion still". Why is that? Does it help or harm the ordinary investor? We shall examine these issues in this article. Thinking vs. believing
This is not a new question at all. Greek philosophers, notably Descartes and Spinoza have debated over this issue centuries ago. Descartes suggested that we first understand an idea, examine its truth and then accept it into our belief system. Spinoza on the other hand suggested that we actually first believed an idea before proceeding to understanding and evaluating it.

At first glance, Descartes seems to be right. In fact, it is basis of the 'rational man' assumed in traditional economics. But in reality Spinoza is closer to the mark and captures our inherent irrationalities.

This question is also vital from an investor's standpoint. It has direct implications on how rational his investment decisions end up being.

How can investors monitor their beliefs?

  1. Examine existing beliefs: Investors should analytically asses their beliefs and regularly put them to test of reality. It may be noted that it is a demanding process that requires mental energy and time. Nonetheless, the genuinely serious investors have to go through this process. Even Warren Buffett has had to. For instance, consider this statement: "My own thinking has changed drastically from 35 years ago when I was taught to favor tangible assets and to shun businesses whose value depended largely upon economic goodwill... Keynes identified my problem: The difficulty lies not in the new ideas but in escaping from the old ones. Ultimately, business experience, direct and vicarious, produced my present strong preference for businesses that possess large amounts of enduring goodwill."

  2. Examine new beliefs: Investors should be very careful when exposing themselves to new beliefs. They should avoid distractions when examining a new idea. Secondly, they should control the flow of information favoring sources more likely to be reliable as against those that generate a lot of noise. Speaking about his investment process, Warren Buffett once said that he does not look at the price of a potential investment until he has read the necessary annual reports and come up with his assessment of its worth. That way, he avoids being influenced by extraneous sources. Investors would also do well to examine reliable sources of information and sticking to them.

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