Most people believe that investing success depends only on the skills of the trade. Value investors believe in buying stocks trading at a discount to their intrinsic value. Growth investors on the other hand, believe in buying stocks in anticipation of future earnings growth. And so on. However, only a few investors give enough attention to their own thoughts when it comes to investing. This can lead to big investing mistakes.
There are many examples of intelligent people getting carried away with their investments. Our thoughts are more important for investing success than our strategy and we should pay more attention to it. Like it or not, the human brain has evolved for survival. In the world of investing, this evolutionary trait might do us more harm than good. We are prone to biases that help our brain take shortcuts in our decision making. These short cuts, called heuristics, are the root cause of most of our investing mistakes. For example, we can believe that luck has played no role at all in a particular stock investment. In reality, luck does play a part especially in the short term. Our biases can cause us to hold on to a losing investment because we refuse to believe that we could be wrong. We can sometimes, be so caught up in our strategy that we forget to pay attention to facts as well as our own reasoning.
A recent survey has proved that these biases are prevalent among young and old investors alike. The level of success and experience of the investor also did not matter. Rich people who are more interested in just preserving their wealth were also found to be prone to making emotional judgments. Young investors were found to give themselves too much credit for successful stock calls during bull markets. The moral of the survey is clear. We all have our biases. Thus it is important to remain humble, as often as it is humanly possible. Humility helps to put our investing success in proper perspective. We can find no greater example of this than Warren Buffett himself. A proper understanding of our investing biases combined with humility will go a long way to make us better investors.
Does your investment framework protect you from emotional biases? Share your views on the Equitymaster Club.