Investing is simple but not easy. As Charlie Munger would say, “It’s not supposed to be easy. Anyone who finds it easy is stupid.”
Clear Your Mind
One of the hardest aspect of it all is psychological. A key element muddying our rational brain is loss aversion. To put it simply, “Losses loom larger than gains” as coined by the economists Daniel Kahneman and Amos Tversky. This means the sensation of loosing 5€ is much stronger psychologically than the feeling of gaining 5€. Though the market is highly automated today, loss aversion still exists and if an investor can recognize that crowd psychology has gone out of hand, it may be a great investment opportunity.
I do believe that you can invest well with average intelligence, it’s simple but not easy. But having the stomach to see your holdings drop by a significant amount (still unrealized) and not sell requires great mental fortitude. The psychological hurt caused by this ignores IQ. Most people find this emotionally agonizing, which is why the majority should just index and disregard the market completely. If you do have the stomach to ignore market fluctuations and trust your facts and reasoning, the discomfort you experience in drops is the price you pay to gain market beating results.
Stick To Mental Models
I am not immune to these feelings of discomfort either. But I do my best to only buy positions in which I am willing to buy more if the price keeps going south. Which brings me to another mental model and checklist item before making any stock purchase: Would you be ecstatic to buy more of a company if the price drops even further (and the fundamentals have not changed)? Let’s say you buy into a position at 12€ and you have valued the business at 20€, a 66% discount. Now the price drops to 10€ (but the value has not changed). Now you’re being offered the same “product” for a potential 100% return. On paper, the logic seems intact. However, acting on these types of price drops is much more difficult due to aforementioned loss aversion.
I like to end these posts with memorable quotes. In his first televised 1980’s interview, the Oracle of Omaha quoted his mentor Ben Graham and said the following:
“You’re not right, or wrong, if a thousand people agree with you. And you are not right, or wrong, if a thousand people disagree with you. You are right because your facts and reasoning are right.”
-IGTSKasimir
Further Reading
Warren Buffett – The Partnership Days (1956 – 1969)
Philip A. Fisher – Lessons From The 15% Man
The Best of Ben Graham – Security Analysis
Phil Town – The Compounding River Guide
Margin of Safety – The Most Important Thing
Intelligent Investing = Thinking In Probabilities
The Emotional Stages of a Value Investor
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