A week ago, I had published an article that went through 17 surprising and important things about the investing world that I think every investor should know. These things come from my accumulated experience as a student of the investing game (over the past 10-plus years) and as a writer and analyst with the Motley Fool Singapore (over the past three-plus years). Earlier today, two other surprising and important things about finance had popped into my head. So, here’s the 18th and 19th to add to the list: 18. Going against the investing-crowd can actually cause physical pain. James…
A week ago, I had published an article that went through 17 surprising and important things about the investing world that I think every investor should know.
These things come from my accumulated experience as a student of the investing game (over the past 10-plus years) and as a writer and analyst with the Motley Fool Singapore (over the past three-plus years). Earlier today, two other surprising and important things about finance had popped into my head. So, here’s the 18th and 19th to add to the list:
18. Going against the investing-crowd can actually cause physical pain.
James Montier is the Head of Asset Allocation at the giant asset management firm, GMO (the firm oversees assets of over US$100 billion). In his book The Little Book of Behavioral Investing, Montier recounted an experiment by psychology researchers Naomi Eisenberger, Matthew Lieberman, and Kipling Williams.
In the experiment, participants were made to play a computer game while their brains were scanned. The participants were told they were playing the game with two other people when in actual fact, the other two people were computers.
After a period of three-way play, the other two “people” started excluding the participant from the game. In the periods of exclusion, the participants’ brain scans showed brain activity in the anterior cingulated cortex and the insula – the exact areas of the brain that respond to real physical pain.
“Doing something different from the crowd is the investment equivalent of seeking out social pain,” Montier wrote. This is a good reminder that investing isn’t easy, especially when there’s a need to go against the crowd.
During the great financial crisis, it looked like bargains were everywhere. Blue chip stocks such as SIA Engineering Company Ltd (SGX: S59), SATS Ltd (SGX: S58), and Thai Beverage Public Company Limited (SGX: Y92) were carrying absurdly low price-to-earnings ratios at their troughs during the crisis as seen in the table below.
Source: S&P Global Market Intelligence
On hindsight, the blue chips were massive bargains. But, it wouldn’t have been easy to invest in them given that their prices were driven to such lows likely as a result of massive selling pressure by the crowd.
To prevent ourselves from falling prey to psychological problems in the future when the market suffers its next inevitable crash (markets will crash from time to time, we just don’t know when), it’d be good to start drawing up plans that can enable us to buy bravely when bargains appear.
19. Professional investment managers can’t always choose the best investing methods for you.
In the 1980s, money manager Robert Kirby had written an article titled The Coffee Can Portfolio which recounted a fascinating personal story of his that occurred in the 1950s.
Back then, Kirby had been managing investments for a female client for 10 years – he was helping her choose stocks to buy and sell – when her husband passed away abruptly. With the death of the husband, Kirby’s client wanted Kirby to handle his portfolio too.
To Kirby’s amusement, he found that the husband “had secretly been piggy backing [Kirby’s firm’s] recommendations for his wife’s portfolio.” But, there was an important twist – the husband only followed the buy calls and had ignored the sell calls.
The end result of that piggy-backing-with-a-twist was startling: The husband’s portfolio ended up being much bigger than his wife’s. In fact, there was “one jumbo holding worth over $800,000 that exceeded the total value of his wife’s portfolio.” That holding was just one out of many stocks within the husband’s portfolio.
Kirby was shocked. But, the discovery pointed out a very important investing idea: Buying and holding shares of great companies for the long run can possibly generate superior returns to actively buying-and-selling stocks. This formed the basis of the Coffee Can Portfolio. Here’s Kirby explaining the concept:
“The Coffee Can portfolio concept harkens back to the Old West, when people put their valuable possessions in a coffee can and kept it under the mattress. That coffee can involved no transaction costs, administrative costs, or any other costs. The success of the program depended entirely on the wisdom and foresight used to select the objects to be placed in the coffee can to begin with.”
To build the Coffee Can Portfolio, Kirby suggested that a money manager can find a large group of stocks with desirable investable-qualities, buy them all in equal proportions, and then simply hold them for a decade or more without doing anything to the portfolio. Such a portfolio can logically do well. Kirby shows why:
“First, the most that could be lost in any one holding would be 2% of the fund. Second, the most that the portfolio could gain from any one holding would be unlimited.”
Unfortunately, the Coffee Can Portfolio was merely a theoretical idea even though Kirby thought it was a great solution. He saw two big problems with the portfolio: (1) The institutional hurdles involved with assembling a team of professionals to construct such a portfolio would be too high to surmount; (2) it was very likely the product wouldn’t take off with clients. “Who is going to buy a product, the value of which will take 10 years to evaluate,” wrote Kirby.
The latter issue is the crux – because of career risk, there are times when investment managers can find it hard to go with the best investing methods they know of. As individual investors, you and I don’t have to deal with such burdens – that’s a big advantage we have over the pros.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any companies mentioned.