I firmly believe that one of the most important things an investor can do is cultivate self-awareness.
Investors big and small have a very rich history of getting in their own way. If everybody could just pause, take a breath and reflect on their history of investing, I think they’d be able to identify where they’ve made mistakes along the way.
Becoming aware of your biases is the biggest step in overcoming them.
Average investors, whether they own units in a mutual fund or stock certificates, are transient owners of a piece of paper. They spend a lot of time looking at what that paper is worth on a day-to-day basis. This leads many investors to get sucked into the day’s news headlines and how they affect the short-term value of investments.
The problem with this is that making decisions based on what has just happened is backward-looking. For example, despite all the warnings of a heated real estate market in the United States, how many investors fled bank stocks before the carnage? How many investors distrust and eschew bank stocks today despite their trading at some of the most inexpensive valuations in a long time?
Unfortunately, many investors might find their biggest foe in the mirror. The chart below shows 20-year annualized returns by asset class (from 1991-2010). It’s tough to keep emotion out of decision-making.
So, rather than obsessing over headlines, we focus on determining what’s special about a specific business. What will allow it to outperform its peers over the next decade? How fragile or impregnable is that competitive “moat”? Who is minding the store? We see that piece of paper as representing our ownership stake in a business.
As a result, we tend to spend very little time forecasting the fortunes of a business over the next six or 12 months. When people ask me the usual “annual outlook” type questions, I tend to respond by looking the other way. In my mind, to think that you have some kind of financial clairvoyance is dangerous.
We’re often most excited when market pessimism is at its highest, and most concerned when the market is overly exuberant. We’re the ones carrying umbrellas around on those cloudless summer days.
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