History of humankind is replete with bad choices by both individuals and nations. The interesting part is that we are predictably irrational. The author explains the X-system and the C-system guts vs brains. How the key for investing successfully is quite simple: prepare, plan and pre-commit to a strategy.

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The book concentrates on the many repeated behavioral mistakes investors inflict on themselves that negatively impact returns in the process. Also, All of these biases can be found outside of investing too — diet, exercise, shopping, and other habits.

Most of our decision-making process is hardwired, having been built around survival over the past , years. Also, it tends to conflict with investing. Montier breaks decision making into two systems: the X-system is the default, quick, emotional responses or the mental shortcuts. The C-System is the slow, logical, deliberate, deductive responses. Most of us believe we run on the C-System. Most of us really rely heavily on the X-System. Because it still works often enough, we trust it more often than we should.

Especially for investing. The bat costs a dollar more than the ball. How much does the ball cost? If it takes five minutes for five machines to make five widgets, how long would it take machines to make widgets? In a lake, there is a patch of lily pads. Every day the patch doubles in size. If it takes 48 days for the patch to cover the entire lake, how long will it take to cover half the lake? Answers: 1. What does the test prove? Example 2: Our inability to factor procrastination into a project.

The solution is to impose deadlines. Investors can prevent empathy gaps by planning ahead. If you want to be able to buy the market when everyone is feverishly selling and not fall prey to similar emotional decisions, then have a plan of attack set up in advance that forces the action.

Sir John Templeton used to set a wishlist of great companies he wanted to buy if they were only cheaper. Since every action must overcome paralysis, what I recommend is a few large steps, not many small ones. A single giant step at the low would be nice, but without holding a signed contract with the devil, several big moves would be safer. It is particularly important to have a clear definition of what it will take for you to be fully invested. The Illusion of Control — we think we can influence the outcome and often mistake randomness for control.

Also, the illusion of control enhances our optimistic tendencies. To me, these sound awfully like the conditions we encounter when investing. We must learn to think critically and become more skeptical. Also, we often confuse confidence in ourselves and others for skill. And worse, we tend to believe the more confident experts, and do so without any level of skepticism. Over-optimism and overconfidence in investing leads to more trading, higher turnover, and underperformance.

Also, men are worse than women. What we can be is more disciplined than the overconfident, over-optimist investors.

Guessing the future is hard. All the evidence points to it being practically impossible without luck. All investors should devote themselves to understanding the nature of the business and its intrinsic worth, rather than wasting their time trying to guess the unknowable future. Different investors have approached the problem of forecasting in different ways. If you are wedded to the use of discounted cash flow valuations, then you may well benefit from turning the process on its head.

Rather than trying to forecast the future, why not take the current market price and back out what it implies for future growth. This implied growth can then be matched against a distribution of the growth rates that all firms have managed to achieve over time.

If you find yourself with a firm that is at the very limits of what previous firms have achieved, then you should think very carefully about your purchase. And we tend to overweight some info, underweight other info, and completely ignore others. Studies show more information does not make us more accurate, just overconfident on our accuracy.

Checklists can help filter the noise from the few pieces of information or factors that really matter. I see my job primarily as asking the right questions and focusing the analysis in order to make a decision. He co-authored a paper in that explored the 50 largest moves in the U. Summers and colleagues scoured the press to see if they could find any reason for the market moves. Press reports on adjacent days also fail to reveal any convincing accounts of why future profits or discount rates might have changed.

Confirmation Bias — we are more likely to look for information that agrees with our conclusions, beliefs, and decisions than disagrees. It appears the more sure people were that they had the correct view, the more they distorted new evidence to suit their existing preference, which in turn made them even more confident.

The solution: We need to go out of our way to prove ourselves wrong. Learn the opposing view. Sunk Cost Fallacy — the tendency to allow past costs like time, money, emotion, or effort to affect current decisions. Researchers have shown that in a series of experiments using urns…people tend to underreact in unstable environments with precise signals turning points , but overreact to stable environments with noisy signals trending markets. This helps explain why economists and analysts tend to miss turning points in the market.

They get hung up on the stable environment and overreact to it; hence they miss the important things that happen when the environment becomes more unstable a recession starts and underreact to such developments. It severely distorts our mental representation of the world. Every stock covered in the media is given a story.

IPOs literally go on a roadshow to spread their story. Then there are story stocks, which trade not on fundamentals, but hope and promise of future potential. All these stories affect our views. Almost all have an emotional pull to it. They also tend to be relatively expensive. For instance, the average sales growth for a company in the most-admired list is 10 percent per year over the last two years. In contrast, the despised stocks seem to have been disasters, with an average sales growth of just 3.

Thus the admired stocks have great stories and high prices attached to them, whereas the despised stocks have terrible stories and sport low valuations. Which would you rather own? Psychologically, we know you will feel attracted to the admired stocks. They significantly outperform the market as well as the admired stocks. Focusing on the cold hard facts soundly based in real numbers is likely to be our best defense against the siren song of stories.

Example: Several people recognized the housing bubble in advance but no one knew when it would burst. Myopia — extreme focus on the short term. Over-optimism, the illusion of control, self-serving bias, myopia, and inattentional blindness help prevent us from seeing bubbles. All eventually burst.

New investment in the area germinates confidence slowly. Euphoria — Prices can only go up is the story. New valuation metrics are created to replace the old and justify higher prices. Over-optimism and overconfidence abound. Speculation runs rampant. Financial Distress Critical Stage — The weight of excessive leverage shows signs of cracking, fraud is found, insiders sell, prices fall, and margin loans are called.

Revulsion — Panic ensues, investors would rather sell at any price than own it. The worst cases are scarred for life. Long term Individual investors have an advantage over professionals when it comes to investing in bubbles and in general.

They only have to manage their behavior. The details of each bubble are subtly different, but the general patterns remain eerily similar. As such, bubbles and their bursts are clearly not black swans. Of course, the timing of the eventual bursting of the bubble remains as uncertain as ever, but the patterns of the events themselves are all too predictable.

That would be the historical precedent. Self-Attribution Bias — we see success due to skill and failure due to bad luck, out of our control, or blame it on someone something else. Hindsight Bias — the knew-it-all-along-effect. After knowing the outcome, we believe it was more easily predictable than it was at the time. The solution: keeping a record of the reasons behind investment decisions and track the outcomes — skill right for the right reasons , good luck right for the wrong reasons , bad luck wrong for the right reasons , mistakes wrong for the wrong reasons.

It holds us accountable for our original views before the outcome. However, at a five-year time horizon, 80 percent of your total return is generated by the price you pay for the investment plus the growth in the underlying cash flow.

These are the aspects of investment that fundamental investors should understand, and they clearly only matter in the long term. A study of soccer goalies was taken around penalty kicks. They dove because they wanted to be seen making an effort and would have felt worse had they done nothing and missed.


Similar authors to follow

For many investment professionals James Montier is behavioural finance. Its largely through Montier that concepts like anchoring, hindsight bias, herding etc. Too few read books, instead the source of information is papers from investment banks. Hence there is a need for a bridge between theoretical advances and investment practitioners. For behavioural finance Montier has been this bridge and a whole generation of investment professionals is wiser as a result. This is Montiers second book.


The Little Book of Behavioral Investing by James Montier

Reports of the death of mean reversion are premature This was originally written for the FT, but they seem to have gone the same way as so much media and are dumbed down these days - they said it was too technical after sitting on it for more than a week. Investing based on mean reversion will be less compelling II. Tail hedging becomes more important IV. Historical benchmarks and correlations will be challenged V. Less credit will be available to sustain leverage and high valuations Implications IV and V seem pretty reasonable to me. However, reports of the death of mean reversion are premature.


Behavioural Investing


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