The psychology of investing #1

The Internet is brimming with resources that proclaim, “nearly everything you believed about investing is incorrect.” However, there are far fewer that aim to help you become a better investor by revealing that “much of what you think you know about yourself is inaccurate.” I am beginning this new series of posts on the psychology of investing, where I will take you through the journey of the biggest psychological flaws, we suffer from that causes us to make dumb mistakes in investing. This series is part of a joint investor education initiative between Safal Niveshak and DSP Mutual Fund.

Anne Scheiber was 51 years old when she retired from her job as a low-level auditor from the American Internal Revenue Service in 1944. She never earned a salary of more than $4,000 per year, and although she was an exemplary worker, she never received a promotion. Maybe, because she was a woman and a Jew, the lots that were discriminated against in the workforce in general in the west during that period.

As per the executor of her Will, Benjamin Clark, Scheiber, who was already investing her small savings in the stock market when she retired in 1944, started her post-retirement life with a portfolio of about $21,000. Adjusted for inflation, that was about $297,000 in today’s money. Not really a large sum to retire in the US.

However, unlike most people, the story of Anne does not end with her retirement at age 51, with $21,000. That’s what most of us are looking for, right? A kitty good enough so that we hang our shoes and suits and retire to a happy, peaceful life?

But Anne’s story continued for another 50+ years, till 1995, when she died at an age slightly above 101. By that time, her investment portfolio was worth $22 million! That’s about $36 million in today’s money.

Now, if you are awed with that number, please note that Anne created this $22 million from $21,000 at an investment rate of return of just 14.6%. This was almost double the US S&P 500 index’s annual return of 7.5% during that period.

So, how did Anne do it? Was she a super investor?

Before I share what helped Anne create such massive wealth, let me tell you the story of Eike Batista, the founder and former chairman of Brazilian conglomerate EBX Group.

In early 2012, Batista had a net worth of US$ 35 billion, ranking him the seventh wealthiest person in the world, and the richest in Brazil. He publicly boasted that he would overtake Mexican billionaire Carlos Slim to become the world’s richest man by 2015.

But by early 2014, his net worth had plummeted to a negative number, due to his debts and his company’s falling stock prices. A few leading business magazines notoriously put him among the fastest destroyers of wealth ever.

Batista was later convicted for bribing and other corruption charges, and was sentenced to 30 years’ imprisonment.

Morgan Housel wrote in his brilliant book The Psychology of Investing that when it comes to money, how you behave is more important than what you know.

Anne was not a super investor. She had an extremely high savings rate and invested all of that in a diversified basket of high-quality stocks and let compounding work uninterrupted for 51 years. In simple words, she behaved well with her wealth over a span of fifty long years and ended a millionaire.

Against this, Eike who was once counted among the leading business owners in the world misbehaved with his and his stakeholders’ wealth and destroyed billions.

You Are Your Own Worst Enemy

Ben Graham, called the father of value investing, said – “The investor’s chief problem – and even his worst enemy – is likely to be himself.”

Seth Klarman, another legendary investor, wrote in his book Margin of Safety – “If interplanetary visitors landed on Earth and examined the workings of our financial markets and the behavior of financial market participants, they would no doubt question the intelligence of the planet’s inhabitants.”

If there’s one statement I often yell at myself, especially when it comes to my actions around money and investing, it is this – “How could I have been so stupid, so out of my mind?”

In fact, I believe if you have never yelled that sentence at yourself, you are not an investor. Investing, after all, for all its math and number-crunching, is a journey fraught with a lot of bad behaviours that causes us to commit mistakes that leave us thinking of ourselves as stupid – our own worst enemy.

But why is that? Why do we experience behavioural issues or biases that create challenges in our investing?

The answer lies in the fact that our brains have evolved slowly over time. Evolution takes a very long time, so our brains are well-adapted for the environment of 150,000 years ago in the African savannah. However, they are not as well-suited for the industrial age of 300 years ago and are even less adapted to the information age we live in today.

Our ancestors faced a world of immediate physical threats and survival challenges. Their brains developed to react quickly to dangers, seek food, and find shelter. These instincts served them well in a harsh, unpredictable environment.

Fast forward to the present day, and we find ourselves in a world where the threats are not sabre-toothed tigers but market volatility and financial uncertainty. The same neural circuitry that helped our ancestors survive now predisposes us to certain biases and irrational behaviours when it comes to investing, because it’s about making decisions under uncertainty.

We are now prone to a wide range of emotions, which can significantly impact our decision-making process. Sometimes, these emotions lead us to make irrational choices that go against our best interests.

The emotion of fear, for example, can paralyze us, making us hesitant to take necessary risks or compelling us to sell off our assets prematurely at the first sign of trouble.

Greed, on the other hand, can push us to take on excessive risks, often leading to significant losses.

Then, seeing others succeed where we haven’t can spur feelings of envy, which might drive us to make impulsive decisions in an attempt to ‘catch up.’

On to hope, while it can keep us invested during tough times, it can also cloud our judgment, leading us to hold onto failing investments longer than we should.

Finally, when markets are booming, euphoria can take over, causing us to overlook risks and make overly optimistic investment decisions.

And if that’s not all, and the irrationality caused by these emotions at the individual level isn’t enough, they also drive market trends in the short run. In fact, market bubbles and crashes are often the result of collective emotional responses.

That is where this series on the psychology of investing comes in. Through this, I aim to help you deal with the irrationality of your thinking process when it comes to investing your hard-earned money.

Over the next few months, I will take you through a journey of the biggest psychological mistakes we are wired to make as investors, and how to minimize the same.

Note that I am not talking about the elimination of mistakes here, but only minimization. This is because, as I mentioned earlier, our brains have evolved over millions of years, and the way they act and react cannot be changed just by learning about their flaws. And so, minimization of our bad behaviour is the best hope we have to minimize the dumb mistakes we make as investors.

The Internet is brimming with resources that proclaim how nearly everything you believe about investing is incorrect. However, there are far fewer that aim to help you become a better investor by revealing that much of what you think you know about yourself is inaccurate.

This is what I will try to do with this series – share with you insights that will help you learn about the biggest enemy in your investment journey – yourself – and how you can learn to deal with it better.

Buckle up.