The Secret Sauce Of Investing

As an investment coach, I teach and educate people on the mechanics of analyzing and evaluating investments. I have found that over the years, I have been also spending more time coaching people on the emotional and behavioural side of investing. I believe that the greatest impediment to making better investment decisions is not a lack of financial information or education; It is the grey matter between our ears and more specifically, how we react, perceive actions, events, and information that will drive our investing proficiency. It is our emotions that hold us back from making successful investment decisions.

I have a secret I want to share with you. The reality is that our brains and logic are just not wired for investing. It doesn’t matter if you work on Bay Street and have a fancy degree. We all inherit behavioural traits that can cloud our judgment and decision-making. The discipline of Behavioural Finance has identified numerous biases that can impair our investing judgment. Below are some of the more common biases and how we can better control them better so we can make more successful investment decisions.

Groupthink/Herding Bias:

Humans are social beasts, and we are constantly looking for validation. We look to associate ourselves with the winning team, or in this case, winning investments. So, when that next great Initial Public Offering (IPO) hits the market we make a beeline and gobble it up because it’s hip and cool. We do so unfortunately at exactly the wrong moment. We need to resist the temptation of chasing hot trends or the “It” stock (Snapchat or Marijuana stocks anyone?). Instead, we need to develop and stay consistent with a long-term investment strategy and ignore the impulses to buy the next “it” stock that comes along the way.

We need to be looking out for companies and ideas that are not in vogue because chances are the market has punished them so much that the stock could become a decent entry point. Personally, I’m always looking out for companies that can demonstrate that they can be profitable when business conditions are tough because when the pendulum turns (and it usually does), a great opportunity will exist to generate some meaningful returns. Dull, unsexy, and boring companies are truly gold.

We need to shed our groupthink mentality and avoid what the consensus or conventional thinking is on a particular stock or business event. At the very least, we should be challenging what the consensus is saying and also, we need to listen closely to what the consensus does not like as some of those elements have a very strong probability of becoming tomorrow’s winning investments.

Optimism Bias:

When evaluating investment opportunities, it is easy to get immersed in just the positive aspects of the investment. We always should be embracing alternative views and perspectives. When researching a stock, we should obviously be interested in looking at the good things the business is doing. Is it profitable? Does the company sell a product that people will buy again and again? Are they financially strong? It is just as important to take on a bit of a devil’s advocate mindset and map out what could go wrong with the stock. What are the risks the company faces in their industry? Who is their competition? Is there any competition? This seems to be a staple question that is being asked about retail stocks right now given the way Amazon is disrupting the space.

Confirmation Bias:

We need to consume and process information from sources that may not validate or share the same value systems, beliefs, and ideologies as we do. Alternative investing ideologies provide perspective, context and a lot of times, a reality check. If you believe in value investing, you shouldn’t ignore insights from people who study market psychology or technical market indicators. They have nuggets of wisdom from which we can profit. Start following people on Twitter and Facebook who adopt investment strategies that are different from yours.

Recency Bias:

When we invest, we are trying to make rational, intelligent guesses about the future and often we base our future assessments on what is happening in the current moment or recent past. We need to limit making investment decisions solely based on information of the moment and an assumption that the trend will continue into the future. We have to recognize the stories and snapshots of the moment so that we can begin looking at the alternatives. It is from there that we will find the winners of tomorrow. So, when you come across magazine and newspaper covers trumpeting that the stock market closed at a record high, it should act as a flag that the easy money may have been made and that things could potentially get a bit choppy going forward. Conversely, you could be watching the news and see a report about investors becoming nervous about putting money into the stock market, That should perk you up because we could be nearing a moment where we may want consider slowly building positions.

Geographical Bias:

We investors love our home cooking and tend to skew our portfolios heavily into domestic financial assets. The reality is keeping a large portion of of your investments locally is not going give your portfolio the juice it needs to generate long-term meaningful returns. We need to get outside our postal code and embrace the fact that business is a global organism and some of the greatest ideas do not necessarily reside in North America. We need to open the doors.

Easier Said Than Done

Let’s be realistic. Taking all of these actions in a consistent manner is by no means easy and you cannot flip a switch in order to change your investing behaviours. It takes a long time and likely you will get a few scrapes and bruises. It is a process. At the same time it is possible, especially if you have a network around you of resources and people that can keep you on the straight and narrow to manage your investing biases. Managing these behaviours and biases is the secret sauce that can improve our chances of success in meeting your long-term financial and life goals.

Aman Raina is an Investment Coach and Founder of Sage Investors. Follow Aman’s market observations and musings daily on Twitter (@sageinvestors) and Facebook. Visit www.sageinvestors.ca.