Inside An Investor’s Mind

Little more than one year ago, I bought shares in Canada’s largest airline, Air Canada (TSE:AC), at about $9 per share. At the time, my investor geek friends (naturally, I count myself among the geeks) questioned whether jello had replaced the brain previously inhabiting my head.

Historically, you see, the airline industry has not been friendly to investors. That, I suppose, is putting it mildly. For the brutally honest take, lets defer to legendary investor and gazillionaire, Warren Buffett, who called the airline business a ‘death trap’ as recently as 2013.

From one notable quip to another, Buffett offered this in your face sketch:

“If a capitalist had been present at Kitty Hawk back in the early 1900s, he should’ve shot Orville Wright; he would have saved his progeny money.”

So … if I haven’t been invaded by jello, what makes me think I know more about investing than Buffett?

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Research, Research, Research, Before You Buy

Let’s get this out of the way: I fully recognize the limits of my investing chops. Besides, comparing myself to Guru Buffett? Really? He’s a self-made gazillionairre. I’m not. Enough said.

Then what was I thinking?

To start with, life is nothing if not teeming with change. And that includes the aviation industry. So when I read a research report issued by TD Securities (TSE:TD)(TSE:NYSE) that argued the case for AC, saying that the airline was massively undervalued, and slapped a $21 target price on a stock hovering around $9, I took notice.

But, hey, it’s just a research report. And it’s essential to keep these reports in perspective, to understand that the company issuing the report may be self-interested (i.e., they may own the stock directly or through a subsidiary). That if you have ten securities companies issuing reports on one publicly traded company, often, nine will have a ‘buy’ or ‘hold’ recommendation and one lone voice will issue a ‘sell’ recommendation.

What does this all mean? While stock analysis may be informative, prudent and reasonable, it’s also self-promotional. By way of research reports, analysts do what they can to support the investment industry, to get investors to enter and stay in the game.

So while TD’s report was intriguing, it wasn’t enough to convince me to buy AC.

And the $21 target price? Which was more than double the current value?

Every investor must absolutely, positively, take these with a healthy grain of salt, skepticism and doubt. If I’m not making myself clear, how about this: Do NOT make investment decisions based solely on a stock analyst saying a certain stock is about to lift off, destination moon.

Because here’s the thing about target prices: they’re educated guesses, nothing more. Granted, securities analysts have access to more information than your typical investor, and may have more of an understanding of a particular industry and inner workings of a particular company. But, and this is hugely important, they do NOT know where a stock is headed, no matter how confident and blustery they appear.

 


Off Target

Consider a research study published in 2006 by Mark Bradshaw of Harvard Business School and Lawrence Brown of Georgia State University. These two guys examined nearly 100,000 12-month price targets issued by analysts from 1997 to 2002.

And here’s what they found: only 25% of stocks were at or above target at the end of a 12 month period; and less than 50% of stocks exceeded the target (then fell back) at some point during the 12 months.

This is their conclusion:

“Target price forecasts are overly optimistic on average, and … analysts demonstrate no abilities to persistently forecast target prices.

This evidence is consistent with prior findings of low abilities of various experts to forecast interest rates, GDP, recessions and business cycles, and the infrequency with which actively managed funds beat the market index.”

Okay, fine. Then are price targets and analyst reports of any use? Sure. Read the reports. Understand the rationale for slapping on a high price target. But don’t be sold. And certainly don’t let these reports be your only information source upon which investment decisions are made.

Getting back to AC, reading TD’s report was step one. After which I reviewed AC reports issued by other securities firms; researched and compared other airlines based within Canada, USA, and elsewhere; and read domestic and foreign newspapers, searching for information about the airline industry. And after taking time to digest all this information, I made the decision to buy AC.

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The Times, They Have A Changed

It just so happens that as I was contemplating purchasing shares in AC, Warren Buffett was considering buying certain American based airlines. And after word got out that Buffett invested nearly $10 billion in four airlines in late 2016, he had this to say:

“It’s true that the airlines had a bad 20th century. They’re like the Chicago Cubs. And they got that bad century out of the way, I hope.”

As an investor, what did Buffett’s considerable investment do for my psyche, for my decision to buy AC? Reflexively, I experienced a boost, felt good about my call. ‘Hey, look at me, I got in the game before Buffett.’

Then I talked myself down. I mean, what did it really matter that I spotted an investment opportunity before Buffett? It meant nothing other than I may have had access to some similar information. And just because Buffett is buying airlines, that in itself is no reason for me to buy. Because my investment objectives are likely different than his. Because he can afford to lose $10 Billion, and I’ll be hurt if I lose a lot less. And most importantly, even though Buffett is an investing genius, he’s human (gasp!) – no, really, he is – and he too experiences losing investments.

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Higher and Higher … Not

This week, nearly one year after my buy of AC, the stock soared to $22. More than doubling my money. Well, look at that, the TD analyst was right! Uh huh. And on 50-75% of his other predictions he was wrong. So, as my teenage son would say: whatever.

Still, I have to tell you I was feeling good. To my thinking, I bought low, and sold high. The perfect trade. And I rode that wave of satisfaction for about 24 hours. Because the next day, I read a new report issued by TD. Seems that they have now upped their target price to $34. Other securities analysts have also increased their target price, most to the mid and upper 20s, with one lone voice calling for a fall back to the teens.

And for a few minutes after reading these ambitious price targets, jello does jiggle my brain. Suddenly anxious, I’m thinking, uh oh, did I sell too early? The analysts say AC stock is going even higher! I could make even more money! Oh no! Why did I sell?!

The insanity then passes. BuddhaMoneyLama takes hold, reminding me that greed sucks. Telling me to be grateful for my good fortune, for my wisdom to sell at a peak. All is good now. Mental balance returns.

Will AC go higher still? Maybe. Do I care? No. Because I’m no longer invested. Because I’m satisfied with my profit and am now looking forward to investing the proceeds in other companies that offer better value.

And I’m certainly not buying the analysts bluster that the stock will now rise another 75%. I mean, this is what analysts do. If they’re lucky enough to make a correct call on target price, as soon as the price is reached or within spitting distance, they raise their target even higher. ‘Hold forever; the stock will go up, up, up!’ And they do this because it’s their job, to entice more people to invest in the stock market.

Here’s what I have to say to that: don’t succumb to jello brain. Once a security has reached YOUR target price, whether on the upside or down, stay disciplined and sell. Say thank you very much. And move on to the next investment.

 

 

 

 

 

 

 

Optimists Make More Money

Several years ago, believers in the ‘Peak Oil’ theory prophesized that our world had reached the height of oil extraction. Moving forward, they said, oil extraction was doomed to permanent decline before eventually ceasing altogether.

A friend of mine (“Squawker”) was an unwavering proponent of the theory. He was bug eyed passionate about telling all who would listen that when oil supplies get squeezed way, way tighter than the early 1970s oil embargo, our economy and lifestyle will spiral down. And the only thing you’ll be able to count on will be the fact that imminent disaster is just a matter of time.

You see, said Squawker, once oil prices skyrocket, transportation costs will be prohibitive. This will translate to an exorbitant rise in the price of food, since food cost is closely tied to oil cost.

And the next domino to fall will be the suburbs, which will transform into ghost towns. Because extraordinary fuel costs will essentially shut down individual commuting and public transportation. Biblical proportion exodus from nationwide suburbs will lead to higher and higher density and massive congestion (we’re talking Hong Kong style density multiplied by 100) in urban centers convenient for walking and cycling to work.


Squawker Does Not Come Home To Roost

Of course, Squawker was wrong. He was also wrong about impending Armageddon resulting from the Great Recession of 2007-2009. And he was wrong about returning to the gold standard and consequent end of paper money’s reign owing to perceived incompetence and self-interest of central banks worldwide.

I could go on but the point is not to flog Squawker. He’s a good person, smart guy, big heart. And as much as I shrink from labeling anyone, from boxing anyone in with a fixed, unchangeable trait, more often than not Squawker sees life’s glass as half empty.


 Enter Buddha

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Your mind belongs to you. Your perspective belongs to you. You may always choose what you see, and the way in which you see life.


Here’s the thing about pessimism: it rests on the notion of a perceived problem, or even crisis, that cannot be solved. Pessimism says that once we enter economic recession, especially a once-in-a-many-generations-shock-shiver-and-quake-in-your-boots-to-the-financial-system-set-back, you may as well drop the curtain and cut the lights because the party’s over. Pessimism says human ingenuity and capacity for problem solving is limited and finite. Pessimism says that never before seen difficulties, puzzles, and complications cannot be solved so it’s best to run and hide.


Optimists Rock

Optimists have another take. And Optimists, thankfully, dominate our scientific, engineering and business world, especially those in the following countries: South Korea, Japan, Germany, Finland, Israel and the USA. These six countries sit atop the Innovation List.

And individuals resident in these six countries are positively changing the way we live, empowering more and more global citizens through inventions that solve humanity’s problems and raise our standard of living.

Of course, residents of other countries contribute too, but I’d hazard a guess that there’s something about the culture of the six leading countries that encourages and cultivates an outsized share of Optimistic Thinkers and Do-ers.

Moreso than other countries, there’s something in the air or the water or the general rights and freedoms given to people in these six countries that facilitates determination, resilience, perseverance, strength, motivation, enthusiasm and flexibility, all traits common to the glass half full folks.

Unlike Pessimists, Optimists are fond of saying, hey, we sure would prefer to see human and economic development advance on a straight line up. But we’re realists too, and we know that just isn’t going to happen. We know that there are, and will continue to be, hiccups along the way. Two steps forward, one step back, and all that jazz.

And when the step back happens, we don’t freeze up, we don’t wallow and moan and hunker down with a multi-year supply of food, water, guns, and a mind wracked with fear. Nahhhhh! Optimists recognize the step back for what it is, knowing forward movement will soon resume.

As for us folks in the investment game, we know that the step back in the form of economic recession or a particular, fundamentally sound, company falling off the revenue/profit rails for a short time period presents prime opportunity to buy top quality shares on the cheap, paving the way for juicy long-term gains.


Enter Buddha

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The Pessimist complains about the wind. The Optimist expects it to change and adjusts her sails.


Optimism Leads to Success

Some folks attribute Warren Buffet’s unrelenting optimism to the fact that he’s the most successful investor ever and, for those keeping score, the third richest dude on this planet.

But here’s what Bill Gates, Microsoft founder and numero uno on the global rich list, says about his friend Warren:

“Warren’s success didn’t create his optimism; his optimism led to his success. Because optimism isn’t a belief that things will automatically get better; it’s a conviction that we can make things better.”

One research study after another has shown that optimism favorably impacts success of any endeavor. Because those who are optimistic, those who are able to envision a brighter tomorrow, are resilient and don’t hesitate to dust them self off after falling down, again and again and again.

What exactly are the ingredients stirred into the optimist’s mix? Dr. Susan Kobasa (1982) found that ‘resilient’ folks have certain characteristics that contribute to their constructive, positive perceptions:

  • Curious.
  • Accept that change is part of life.
  • Accept that change is essential for growth.
  • Believe in them self; believe that they make a difference and influence change by what they imagine, say, and do.
  • Are intent on making their life experiences meaningful and interesting.

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Looking On The Bright Side

Our brain works kind of like a muscle. Work it, and it grows stronger. Keep it idle, and it atrophies.

Our mental perspective operates in the same way. Grooves for cynical, pessimistic thought are dug deeper, little by little, each time such a thought takes root in your headspace. And if pessimism dominates thinking for an extended period of time, well, that’s going to result in an awfully deep hole, one that will detrimentally color your views on life, including investing and money management. Unfortunately pessimists often seek company from other pessimists, people who think like them, thus reinforcing the dark loop. And the longer the loop persists, the tougher it is to find an exit.

Looking on the bright side comes naturally to some; others have to work hard for it. Take Thomas Edison. Apparently, he ‘failed’ close to 1,000 times before perfecting the light bulb. And he had many other ‘failed’ inventions. Here’s a glimpse into Edison’s mindset:

“I have not failed 10,000 times—I’ve successfully found 10,000 ways that will not work.”

Getting back to Squawker. In 2008, he sold all of his stock market investments at a loss. Then he bought gold bars. And to this day, he holds the gold and hasn’t returned to the stock market. A stock market (let’s use the Dow Jones Industrial Average here) that has gone from a low point of about 6500 to today’s close above 21,000. A gain of about 325%. Easy pickings if he’d just stayed in a DJIA based passive index fund; if he just stayed invested in equities, which is a bet on the global economy, a bet on human resilience and innovation, instead of letting fear lead him astray, to the detriment of his personal finances.

Life, finances, investing … it’s sooooo much about perspective. And perspective is a choice you can make each and every day.


Enter Buddha

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The Optimist believes they are living in the best of all possible worlds. The Pessimist fears this may be true.

 

 

 

 

Emotions Are Not Your Friend

Coming up on ten years ago, during the Oh-My-Goodness-The-Sky-Really-Is-Falling-This-Is-The-Big-One-Retreat-To-The-Bunker-And-Hunker-Down era, a friend of mine I’ll call Dwayne for the purpose of this post, liquidated his healthy, six-figure investment account.

It was 2008, Lehman Brothers had collapsed, Bear Stearns had collapsed, Merrill Lynch had collapsed, panic swept through Wall Street and Main Street, global financial markets teetered, tottered, wobbled, and reeled, and conventional wisdom had reckoned the end of capitalism to be nigh.

Dwayne, certain that impending Armageddon would leave fiat currencies worthless, resolved to eliminate perceived financial danger. He would protect himself and his family by using much of his cash stash to buy gold. Speaking with me about his intentions, Dwayne insisted not only that his actions were perfectly reasonable, they were also the only sane path forward.

Brushing aside my assertions that fear was driving an extreme, irrational response to cyclical market gyrations he, in turn, charged me with misguided hope for the future. Whether fear or hope, the fact is that underlying both of our ways of thinking were, dare I say it, feelings.


Whoa Whoa Whoa Feelings

At their core, investment decisions are emotional decisions. And, unfortunately for investors, irrational, short-term thinking too commonly supercedes logic and reason. The result? We buy or sell a security not based on objective, diligent research but moreso rooted in emotional responses triggered by screaming headlines, doom and gloom pundits or chicken little next door.

Why is it do difficult to block out these meddlesome emotions?

The answer lies partly in the perpetual tug o’ war between two radically different parts of our brain. While the prefrontal cortex wires us for rational, long-term thinking, the limbic system is geared to short-term emotions leading to irrational decisions.

Being human, and being predisposed to fluctuating degrees of emotional bias, we will (make no mistake about it) mess up here or there.

So, for those investors not blessed with Vulcan heritage (for those readers not familiar with Mr. Spock / Star Trek, think ice in your veins), how do you rein in wayward behaviour for the purpose of minimizing risk and maximizing profit?

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Striving for Clarity

Modifying our behaviour (be it investment or otherwise) is not a simple task. If it were, there would be a whole lot more champion investors weighing in on scale with Ben Graham, Irving Kahn, Warren Buffett and Peter Lynch.

Famously, Buffett is quoted as saying,

“The secret of getting rich on Wall Street is you try to be greedy when others are fearful and fearful when others are greedy.”

Aside from his other talents, Buffett understands that emotions play an integral role in investing. For the rest of us mere mortals, we would be wise to emulate the Omaha Oracle and, gulp, get in touch with our feelings (the ‘gulp’ is for the guys, given the guy tendency to shy away from f, f, f … feelings).


Emotional Rescue

A useful starting point is the Investor’s Cycle of Emotions. The Cycle helps to shed light on (a) the kinds of events responsible for activating certain investment related emotions; and (b) how these emotions may affect our decision-making behavior:

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  • Optimism. We buy when feeling positive about the future.
  • Excitement. Paper gains reinforce belief in ourinvesting prowess. We consider how this new money may be put to use.
  • Thrill. When gains grow, overconfidence sets in.
  • Euphoria. As gains continue, we begin ignoring risk and expect each investment to be successful. Here we encounter maximum financial risk.
  • Anxiety. Incurring unrealized losses as investment values decrease we rationalize that, being long-term investors, our investments will ultimately bear fruit.
  • Denial. Markets slide. Investments go into free fall. We bravely maintain confidence in our investment choices and hold onto hope that values will rebound.
  • Fear. The markets unrelenting descent brings confusion. We begin to doubt our investments will ever again increase in value.
  • Panic. Frozen, we do not know what to do.
  • Capitulation. Convinced that our portfolio has suffered irreversible damage, as a matter of eliminating risk to ensure survival, we sell everything.
  • Despondency. We decide never to make another stock market investment. Here, when the herd is despondent, we encounter maximum financial opportunity. [for example, when Warren Buffett agreed to loan $5 Billion to Goldman Sachs during the height of the Great Recession. Three years later, with the recovery underway, Goldman Sachs paid back the loan and Buffett pocketed a tidy $3.7 Billion profit].
  • Depression. We try to makes sense of what we believe to be our foolish actions.
  • Hope. Time heals. Eventually, clouds disperse and we attribute our loss to the reality of experiencing a down cycle. We start looking for new opportunity.
  • Relief. Tentatively, we re-enter the stock market. Our investments turn profitable. Faith returns. The Cycle begins anew.

Sound exhausting? Familiar? In capitalist markets like our own, this scenario plays out time and again because it’s not a matter of if markets go down, but when.

Now, I’m not saying that loss may be avoided simply by cultivating awareness of your emotional responses. But I am saying that, if you know how the typical investor’s emotions play out when bulls stampede or herds blindly rush for exits, then you’ll be in a stronger mental position to dodge infection of fear, act rationally and productively manage your portfolio.


Taming the Limbic System, Maximizing Investment Dollars

Because excessive emotional reactions will make for an unhappy investor, the best you can do is learn to understand and effectively manage your emotions.

Alternatively, farming out decision making to an objective, emotionally detached Robo-Advisor or one of the human variety, may be worth looking into. Whatever you choose, keeping a lid on detrimental emotions is important.

One of these destructive mental states is GREED. Left unharnessed, greed is powerful. And when greed takes over, when logic is shunted to a corner and we watch an investment run up 25%, 50%, 100%, 200%, and continue holding on because we’re hoping for more so we can buy that new car or take that European vacation, we perilously ignore the unlikely repeal of the law of gravity.

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So how do you soften the penchant for wanting more? Focus on risk management. Focus on the possibility of losing instead of winning. Focus on satisfying your needs instead of wants. Ask yourself whether, based on prudent research, you would make an investment at the current price. If not, then let reason be your guide, stay disciplined to your exit strategy and listen to the voice imploring u to ‘sell’ when your target price flashes green.

Another harmful way of thinking involves OVERCONFIDENCE. Research shows that close to 75% of people judge themselves better than average at, well, everything. Of course, by definition, about half of any group must be less than average.

In the realm of investing, overconfidence leads investors to take on more risk than initially anticipated, commonly deviating from a methodically crafted investment plan only to be trampled by emotions gone wild.

And when stocks go down, emotions again push reason to the sidelines. Investors continue to hold, often believing that by not selling they will avoid the pain and regret of having made a poor investment decision and embarrassment of reporting a loss on their tax return, or telling their accountant or spouse.

First comes losses, second comes pain, third comes regret.

Behavioral finance experts claim that the prevalence of fear of regret stems from people’s unwillingness to accept responsibility for pain they caused themselves. And when you’re stuck in the regret phase, you’re mired in the past, beating yourself up, and unable to get back in the game.

Since wallowing doesn’t benefit anyone, for your own well being, it’s essential to ride out regret by learning to accept loss, accept mistakes, and acknowledge the fact that even well-researched investments may, and will on occasion, turn sour. Once you’re moving forward, remember to carry with you lessons learned and, in the future, stick to an investment plan honed during a period of calm reflection.


Hope is not a Strategy

Too many folks are prone to chasing investments whose value is going up. According to research, we become overly optimistic about past stock market winners and excessively pessimistic about past losers.

Apparently, neither optimism nor pessimism is justified since, over time, extreme winners underperform and extreme losers outperform. Yet, we can’t help ourselves. Maybe we’re just too excited to hop on for the ride, carried away by the hope that we’re going to hit it big.

Consider this little gem:

As of March 13, 2017, a company called Stemcell United (ASX:SCU) was effectively worthless trading at one penny on the Australian Stock Exchange. Then, on March 14, 2017, the company issues a press release stating, “SCU to pursue opportunities in Medicinal Cannabis sector.’

Well, this general, vague, zero details statement was enough for speculators to move the price to $1.09 on March 14. That’s right, from one penny to $1.09 in one day. Insane. Still, before the day was out, the stock closed at 41 cents. And as of yesterday, the stock was priced at 13 cents.

The outrageous stock price movement had nothing to do with company fundamentals: the company has no revenue, sells no product and offers no service. But what it did have was a statement saying that it would enter the potentially lucrative marijuana industry. And that was enough to fuel the dreams of hordes of speculators.

The point being: whether you’re buying a penny stock or a behemoth like Apple (NASDAQ:AAPL), you’ve got to look in the side view mirror, the one where it says that past performance gives no indication of future returns. Then look ahead and keep in mind that investments should be made on the basis of solid business fundamentals and favorable prospects, not because hopes and dreams spurred us to the bottom of an investor pile on.


Embrace the Rational Path

Human nature is inherently paradoxical.

Impulses and emotions clash against reason, contributing to adverse investment decisions. As investors, our goal is to discipline the mind such that we recognize emotional reactions and learn to manage their potentially harmful consequences. And though there is more than one path to investing success, all include abiding by decision-making emphasizing cold logic rather than runaway emotions.

Whatever path you choose, consider what ninety-three year old Charlie Munger, Berkshire Hathaway vice-chairman, said when asked how he became such a successful investor: “I’m rational.”

Is Warren Buffett Buddha?

The other evening I’m reading about spirituality issues related to Buddhism and Yoga. And I’m deep in focus, taking it all in, and trying to make sense of what are to me new ideas, new ways of thinking, novel perspectives that may help me better understand myself and my connection to this world we live in. Continue reading “Is Warren Buffett Buddha?”