James Montier’s addition to the “Little Book” series on investing could have been on practically any topic; however, his focus on investor psychology and his grasp on human irrationality in investing made him the clear candidate for the behavioral portion of the collection. The book, while not nearly as in-depth on the biological aspect of our biases as Jason Zweig’s “Your Money and Your Brain” (not necessarily a bad thing), covers a wide range of topics, and provides a basic framework for understanding the behavioral hindrances that hold many individual investors back from successful investing. Here’s a preview of some of the discussions:
One that is key for any contrarian investor is empathy gaps, which covers the idea that human understanding is generally “state dependent.” The most popularized quote on this topic is Sir John Templeton’s famous mantra: “The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.” Unfortunately, this is easier said than done; everybody talks about March 2009 as if they couldn’t get enough of equities, when the reality is that they had hit bargain-bin prices only because investors wouldn’t go near them.
The question is, how do we overcome this bias? Montier recommends that we follow the seven Ps – “Perfect planning and preparation prevent piss poor performance.” One great example of this comes from none other than Sir Templeton, who understood the difficulty of overcoming this bias and planned accordingly during moments of rational thought; he would keep a “wish list” of stocks that he believed were well run, but substantially overpriced. In addition, he kept standing purchase orders with brokers to execute buys at prices he considered a bargain, a level that was usually only reached during a market correction or period of widespread fear. This pre-commitment is a great example of putting a widely professed (but rarely implemented) contrarian philosophy into action.
Another bias discussed in “The Little Book of Behavioral Investing” is confirmation bias, and the idea that we should focus on the process, rather than the outcome of our investments. This is especially true over the short term: for me personally, I know that any time I buy a stock and see it 5 percent higher a week down the road, I can’t help but to think what a genius I must be; however, this is often just short term price volatility (which is much more rampant than fundamental volatility), and looking to it for investment approval is a sure-sighted plan for failure.
Even over an extended time period, it is important to seriously consider whether our investment success is due to deserved success or dumb luck. Naturally, it is difficult to sit back after watching a stock appreciate 30% over 2-3 months and conclude that you were wrong. However, the investor who seriously analyzes their prior successes and accepts that “dumb luck” has impacted certain outcomes can avoid repeating their miscalculations; for those that continue to march ahead blindly, they are on a direct path for what can only be described as “poetic justice.”
At the end of the day, this book is an invaluable resource, but only if properly used. On its own, reading this book isn’t very likely to make you a better investor; the overwhelming pull of the biases discussed are tough to overcome through thought exercises alone, as evidenced by widespread euphoria and panic by the broader investment community during times of boom and bust, respectively. However, for the investor who takes the time to implement some of Montier’s ideas (like an investment journal to realistically test previous beliefs), this book will act as a stepping stone towards developing a sustainable competitive advantage over an emotional and often irrational market.
Disclosure: I paid for my copy of this book and will not benefit in any way from readers’ purchases.
One that is key for any contrarian investor is empathy gaps, which covers the idea that human understanding is generally “state dependent.” The most popularized quote on this topic is Sir John Templeton’s famous mantra: “The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.” Unfortunately, this is easier said than done; everybody talks about March 2009 as if they couldn’t get enough of equities, when the reality is that they had hit bargain-bin prices only because investors wouldn’t go near them.
The question is, how do we overcome this bias? Montier recommends that we follow the seven Ps – “Perfect planning and preparation prevent piss poor performance.” One great example of this comes from none other than Sir Templeton, who understood the difficulty of overcoming this bias and planned accordingly during moments of rational thought; he would keep a “wish list” of stocks that he believed were well run, but substantially overpriced. In addition, he kept standing purchase orders with brokers to execute buys at prices he considered a bargain, a level that was usually only reached during a market correction or period of widespread fear. This pre-commitment is a great example of putting a widely professed (but rarely implemented) contrarian philosophy into action.
Another bias discussed in “The Little Book of Behavioral Investing” is confirmation bias, and the idea that we should focus on the process, rather than the outcome of our investments. This is especially true over the short term: for me personally, I know that any time I buy a stock and see it 5 percent higher a week down the road, I can’t help but to think what a genius I must be; however, this is often just short term price volatility (which is much more rampant than fundamental volatility), and looking to it for investment approval is a sure-sighted plan for failure.
Even over an extended time period, it is important to seriously consider whether our investment success is due to deserved success or dumb luck. Naturally, it is difficult to sit back after watching a stock appreciate 30% over 2-3 months and conclude that you were wrong. However, the investor who seriously analyzes their prior successes and accepts that “dumb luck” has impacted certain outcomes can avoid repeating their miscalculations; for those that continue to march ahead blindly, they are on a direct path for what can only be described as “poetic justice.”
At the end of the day, this book is an invaluable resource, but only if properly used. On its own, reading this book isn’t very likely to make you a better investor; the overwhelming pull of the biases discussed are tough to overcome through thought exercises alone, as evidenced by widespread euphoria and panic by the broader investment community during times of boom and bust, respectively. However, for the investor who takes the time to implement some of Montier’s ideas (like an investment journal to realistically test previous beliefs), this book will act as a stepping stone towards developing a sustainable competitive advantage over an emotional and often irrational market.
Disclosure: I paid for my copy of this book and will not benefit in any way from readers’ purchases.
