“Those who can make you believe absurdities, can make you commit atrocities.” - Voltaire
If you have been investing in the markets for the last 1 year, then you would have seen your portfolio value soar anywhere from 25 - 100%, irrespective of you having chosen Equities, Crypto, or Index ETFs.
And with Success comes the illusion that it was your skill that made you earn these astronomical returns. With continued success in Investing comes the overconfidence of being able to pick the securities that will go up. With overconfidence comes the illusion of certainty which makes you go all-in with bigger bets and expectations of bigger home runs.
It’s all good till the party goes on. But as is often said, “Trees don’t grow to the sky”. That’s exactly what happened in the last 3 months. Many growth stocks have crashed anywhere from 30% - 60%. Crypto assets have also corrected between 20% - 30%. Fintwit has gone silent with nobody sharing their portfolio screenshots. No TikTok videos from Crypto Bulls with their new Ferraris or Lamborgini. Luckily, it’s got more real in the social media space.
This could be the reason to be upset about your portfolio performance or it could be an invitation to apply for the new role opening up - VP, Skeptical Analyst Department in the Wealth Creation Unit of your Own Enterprise.
“Confidence gets you off to a fast start. Confidence gets you that first job and maybe the next two promotions. But confidence stops you from learning. Confidence becomes a caricature after a while. I can't tell you how many confident blowhards I've seen in my coaching career who never get better after the age of forty." - Bill Walsh, one of the best American Football coaches of all time
During my research, I came across a 2011 article in TIME magazine which talks about humans being wired for optimism, especially where it comes to their own personal prospects in the future via-a-vis prospects of society or community in general. Let’s take a look at few excerpts from there -
We like to think of ourselves as rational creatures. We watch our backs, weigh the odds, pack an umbrella. But both neuroscience and social science suggest that we are more optimistic than realistic. On average, we expect things to turn out better than they wind up being. People hugely underestimate their chances of getting divorced, losing their job or being diagnosed with cancer; expect their children to be extraordinarily gifted; envision themselves achieving more than their peers; and overestimate their likely life span (sometimes by 20 years or more).
Overly positive assumptions can lead to disastrous miscalculations — make us less likely to get health checkups, apply sunscreen or open a savings account, and more likely to bet the farm on a bad investment. But the bias also protects and inspires us: it keeps us moving forward rather than to the nearest high-rise ledge. Without optimism, our ancestors might never have ventured far from their tribes and we might all be cave dwellers, still huddled together and dreaming of light and heat.
It’s our flawed design that we go long on stocks and not short. It’s our inbuilt optimism that makes us buy into dreams and grandiose visions. It’s our hope that makes us live on debt, smoke, and drink to glory. It’s our wish that our gambles pay off in time. It’s easier to be optimistic rather than being pragmatic.
If any of you have watched the Wirecard Documentary on Youtube, there comes a moment around 42 mins into the video, you witness Markus Braun, CEO & CTO of the bankrupt Wirecard stating “I am a pathological optimist”. And he made this statement in spite of damning evidence against Wirecard by Financial Times, Fraser Perring, Fahmi Quadir, and many other high-profile short-sellers globally.
This pathological overconfidence is wired into all human beings in various degrees and it is known through various names e.g. overconfidence bias, Dunning-Kruger effect, hindsight bias, base rate neglect, framing effect, hot hand fallacy and so many more.
You are demonstrating this bias if you are thinking that you are smart enough to not get seduced into believing the stories being cooked into your thinking. If you still have doubts, then let’s take a few lessons from Nike’s dominant position in the world of sports apparel.
There was a statement in there that hit me hard, “When emotions jump, intelligence drops”. Halo Effect is used against you by every firm, marketer, influencer, TV anchor, AMC, PMS, Trader, Broker, and everyone who is interested in selling his wares to you.
If you consider what happened since March ‘20, it’s been a bountiful ride for investors globally. From 31st March 2020 to 1st Feb 2021, the movements in markets has been as follows -
Nasdaq - 67% ⬆️
S&P 500 - 44% ⬆️
BSE Sensex - 70% ⬆️
ARKK - 229% ⬆️
Apple - 112% ⬆️
Doge Coin - 2900% ⬆️
Irrespective of when you entered the markets in this period or which security you bought, you would have surely made substantial returns. And the reasons I pick this specific period are (a) Stimulus checks finding it’s way into retail investors hands (b) Boredom from quarantine leading to stock picking replacing sports betting and other social activities (c) Elon Musk and other Venture Capitalists going all-in on crypto (d) Reddit community storming against Hedge Funds with Gamestop (e) Influencers becoming Investment Advisors and sharing their daily profits and buy/sell trades as shown below.
When everyone around you is shouting out loud that the trees will grow to the sky, chances are high that you will get sucked in and that’s exactly when your over-optimism starts inducing you to drop your defenses and make trades where your margin of error is low and risk of ruin is high.
“If we put our head in the lion’s mouth, we shouldn’t be surprised if it’s bitten off” - Peter Bevelin
I personally know friends who bought DogeCoin at 60+ cents and saw it going to less than 40 cents in less than a week. That is 33% wiped off, in a week. Friends invested in Palantir have lost 50% in less than 6 months. Investors in hypergrowth companies like Fubo TV have lost 66% since Dec ‘20 i.e. 2/3rd capital erosion in less than 6 months.
To lose 66% means USD 100 turns to USD 34. Now to go back to USD 100, the stock has to appreciate almost 200%. That is a rare phenomenon, especially in an economy where capitalism is brutal to the point of draining profits out of a sector that seemed inviting and lucrative just a few years back.
It’s at times like these that you must go back to the drawing board and revisit the Investment process you follow. It’s in the tough times that you realize the importance of building guard rails so that you don’t fall into a trap again. In the Wirecard documentary, they cover the story of a 66-year-old guy who bets his entire life savings in Wirecard stock and loses it all, eventually leading to him begging for a Seaman’s job with his old employer. You don’t want to be in a situation like this one.
These ain’t one in a million stories. These are stories taking place daily and mostly by people who do not have a process in place. And without a process, it’s the emotions that control you and the best storyteller gets to win your money and play or party with it.
The novelist Henry James wrote that life is “all inclusion and confusion,” while art is “all discrimination and selection.”
If you have enjoyed and entertained all inclusion and confusion since March 2020. It’s time to exercise some discrimination and selection going forward. It is time to ask fundamentally important questions to yourself. It is time to think and make some difficult choices, only if compounding your wealth matters to you.
For starters, I could provide you some questions to begin this introspection process -
Why did you buy that security?
Why did you believe your friends?
Why didn’t you diversify / why did you concentrate on few stocks?
What bad habits are you seduced into?
What excuses are you giving to not spend time doing quality research?
Is there even a process in place to decide on what to buy/sell and why?
What emotional biases do you give into?
What assumptions are you operating from?
What checklist do you use for making decisions?
Who's playing the role of Devil’s Advocate?
There could be so many more questions if you could sit down quietly and think. But sitting down ain’t as easy as consuming market news and acting on impulse or emotion. Hence Blaise Pascal, the seventeenth-century French mathematician, said, “All of humanity’s problems stem from man’s inability to sit quietly in a room alone.”
Warren Buffet spends 10 + hours daily just reading and thinking. Howard Marks does the same. Charlie Munger, Mohnish Pabrai, Chris Bloomstran, Phil Ordway, Elliot Turner, and many other investors spend a considerable amount of time reading and thinking. These are multi-billionaires/millionaires with a very pristine reputation in the Investment industry.
Rahul Mathur is a very interesting entrepreneur in India’s Insurtech space and is a name to watch out for. His firm BimaPe is a fast-growing Insurance platform and he does an incredible job of building his company in public. He shares his takeaways, what he is implementing in the firm, his struggles, his triumphs, major milestones, and breakdowns. Being an entrepreneur is equivalent to juggling 10 balls while you are driving on the roads of Mumbai. If he can take time out to read and think to chart his course ahead profitably, I see no reason why we shouldn’t.
For a rational skeptic, the point is not to be permanently pessimistic; it’s to question what “everyone” believes to be true, whether it’s too positive or too negative. Explaining his epiphany, he wrote: “Skepticism calls for pessimism when optimism is excessive. But it also calls for optimism when pessimism is excessive.” - Howard Marks
“Times of laxness have always been followed eventually by corrections in which penalties are imposed.” - Howard Marks
Don’t drop your guard again. Market movements repeat and it will catch you again in the most unexpected manner, just like it did with the COVID pandemic in 2020 or the inflation jitters moving the markets recently. We can’t control the events in the market, but we can control our process and our mindset. That’s pragmatic investing and it’s way better than just being long at all times and in all things.
I extend my invitation to you for donning the Skeptical Analyst hat from today onwards. It’s time.
Wishing you loads of luck and many home runs.
Manish