Lessons from Charlie Munger-IX - Views on News from Equitymaster

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

Lessons from Charlie Munger-IX

Dec 29, 2011

In the previous article, we had discussed how a simple emotion like jealousy could prompt you into making irrational investment decisions. Today, we shall discuss our innate tendency to be over-optimistic and how it affects our view of the economy and the stock markets. Our aim is to help you understand the workings of your mind better so that you do not let your biases and thinking errors jeopardise your investments.

Over-optimism tendency

It is indeed commendable how humans and other creatures have evolved and survived over millions of years of evolution. Forget millions of years. Just look at all that has happened in the last 100 years, a period which saw two major world wars and a series of economic and political crises across the globe. Yet we continue to look forward to a better future. What is it that allows man to endure the many trials and tribulations that life presents? Hope, isn't it?

Charlie Munger shares a very interesting perspective in this regard. He opines that an excess of optimism is the normal human condition. And this tendency to be over-optimistic not only manifests when man is in pain, but also when he is doing well and there is no threat of pain whatsoever. A famous Greek orator by the name of Demosthenes is known to have said these very fitting lines more than 2,000 years ago-"What a man wishes, that also will he believe."

Over-optimism tendency in stock markets

It is not at all difficult to understand how this tendency drives not just stock markets but the entire world of finance and economics. Why otherwise would we have booms and bubbles with such amazing regularity? Why do people continue to flock to the financial markets despite the regular crises and busts that torment the markets? In fact, all the malaise troubling the global economy today, from the debt crises in the developed economies to the high inflation and slowing growth in emerging economies like India, do have roots in excessive optimism. The problem is that when things are good, we expect them to get better and better in a linear fashion. And even when things are bad and getting worse, we often expect that the situation will turn good again sometime in the future.

This tendency is so often displayed by company managements. During good times, they tend to get over-optimistic and take up massive debt-funded expansion plans by way of capacity additions or wasteful mergers and acquisitions. When the cycle turns and things turn sour, you see red ink all over their financial statements. What is surprising is that even in bad times, a lot of companies are extremely shy to admit that things are not going too well. They tend to project and hope only what they wish to see and not what there is really.

As investors, the best way to deal with this bias is to acknowledge that it exists in the first place. That is half solution done because most of the times we are not aware of our own biases. Then a very effective antidote to over-optimism is to challenge your views by asking yourself as many questions as possible. If your views cannot stand the attack of reason, you know which tendency is to be blamed.

We will continue to discuss some more thinking errors and psychological tendencies that can affect your investment decisions in the subsequent articles of this series.

Lessons from Charlie Munger Article Series - Previous article| Next | | All Articles
Try the Charlie Munger Quiz


Equitymaster requests your view! Post a comment on "Lessons from Charlie Munger-IX". Click here!

  

More Views on News

How Much Money Should an Investor Set Aside for Trading? (Fast Profits Daily)

Sep 21, 2020

In this video, I'll give you a simple equation which you can use to decide how much money you can set aside for trading.

Kotak Standard Multicap Fund: Strategizing Growth with Focused Approach (Outside View)

Sep 21, 2020

PersonalFN's analysis on the features and performance of Kotak Standard Multicap Fund.

Sensex Can Go to 25,000 Before it Goes to 60,000. Are You Prepared? (Profit Hunter)

Sep 21, 2020

Am I expecting a big crack in the Sensex and what next?

What Do the Charts Say About Buying Smallcaps Now? (Fast Profits Daily)

Sep 18, 2020

Everyone seems to be excited about buying smallcaps now...but is it the right thing to do? What do the charts tell us? Find out in this video...

Sundaram Bluechip Fund: Will Hold the Stable Horses (Outside View)

Sep 18, 2020

PersonalFn briefly outlines the newly launched NFO note HSBC Corporate Bond Fund.

More Views on News

Most Popular

Top Investing Gurus of India

Investing gurus are the champions of value investing. These are the people who've mastered the art of compounding wealth from...

How the 8-Year Cycle Can Help Identify Multibaggers (Fast Profits Daily)

Sep 11, 2020

This is how you can apply the greed and fear cycle in the market to pick stocks.

Why am I Recommending Caution? (Fast Profits Daily)

Sep 9, 2020

This is why I have changed my short-term view on the market.

This Could Be the Best September for Auto Stocks (Profit Hunter)

Sep 11, 2020

Here's why I think this month could be a great for auto stocks.

Why We Picked This Small-cap Stock for Our Hidden Treasure Subscribers (Profit Hunter)

Sep 17, 2020

This leading household brand will profit big time in a post covid world.

More

Covid-19 Proof
Multibagger Stocks

Covid19 Proof Multibaggers
Get this special report, authored by Equitymaster's top analysts now!
We will never sell or rent your email id.
Please read our Terms

S&P BSE SENSEX


Sep 21, 2020 (Close)

MARKET STATS