Seven Sins of Fund Management

Investing is fighting against emotions and biases continuously. Now and then it is worthwhile to remind yourself of the most common sins. Although you know they exist, they will intertwine with your trading habits and kill your returns.

The first is placing forecasting at the very heart of the investment process. An enormous amount of evidence suggests that investors are generally hopeless at forecasting. So using forecasts as an integral part of the investment process is like tying one hand behind your back before you start. (Pride)

Secondly, investors seem to be obsessed with information. Instead of focusing on a few important factors (such as valuations and earnings quality), many investors spend countless hours trying to become experts about almost everything. The evidence suggests that in general more information just makes us increasingly over-confident rather than better at making decisions. (Gluttony)

Thirdly, the insistence of spending hours meeting company managements strikes us as bizarre from a psychological standpoint. We aren’t good at looking for information that will prove us to be wrong. So most of the time, these meetings are likely to be mutual love ins. Our ability to spot deception is also very poor, so we won’t even spot who is lying. (Lust)

Fourthly, many investors spend their time trying to ‘beat the gun’ as Keynes put it. Effectively, everyone thinks they can get in at the bottom and out at the top. However, this seems to be remarkably hubristic. (Envy)

Fifthly, many investors seem to end up trying to perform on very short time horizons and overtrade as a consequence. The average holding period for a stock on the NYSE is 11 months! This has nothing to do with investment, it is speculation, pure and simple. (Avarice)

Penultimately, we all appear to be hardwired to accept stories. However, stories can be very misleading. Investors would be better served by looking at the facts, rather than getting sucked into a great (but often hollow) tale. (Sloth)

And finally, many of the decisions taken by investors are the result of group interaction. Unfortunately groups are far more a behavioral panacea. In general, they amplify rather than alleviate the problems of decision making. (Wrath)

For further reading, click here (pdf) or watch this video by The Compound

The Trade War Is Exposing What Little U.S. Tech China Still Needs

Bloomberg.com

A trade war between the world’s two largest economies erupted this year, and technology is at the center of the skirmish. President Donald Trump blocked networking giant Huawei Technologies Co. from buying U.S. components, and put tariffs on many Chinese products. China responded by threatening to blacklist U.S. companies. The rising tension is testing a complex relationship, especially in tech where the U.S. and China are tightly intertwined through global supply chains and software that can zip across borders with the tap of a computer key. So which country has the most to lose? Who needs the other nation more?

Why you should start investing in your twenties, and ignore your environment.

Source: Pixaby

The market is changing their focus continuously. At one point the debt crisis in Greece is of global concern and the next week it is data in China that is not beating expectations. Both events heavily impact the stock exchange. The numbers are ticking up and are ticking down. In a healthy stock market, the fluctuations are common and ensures an equilibrium. However, people do want an explanation for it and the media will give it to them. No matter what. As an investor, the pitfall will be to join the anxiety and greed movement. Trade on every issue or don’t invest because the hell will definitely break lose, according to the top stories on Twitter.

That is not all, your non-financial environment will join this movement. They are not looking at the stock market at a daily basis and therefore will hear mostly the negative stories. In their opinion short term profits are the key and will only justify the time you spent on doing research. Investing in stocks is the same as going to the casino. Numbers are coming your way or numbers are going to your counterpart. The recurring conclusion is: you are gambling with money. Instead of gambling, they suggest that you invest in a nice house and a nice car. Oh, and by the way: what about Bitcoin?

If you join this anxiety and greed movement, you will indeed probably gambling with money. You will try to predict which way the market is moving in the next month. Once you are part of the movement, the every day breaking news nonsense will definitely toxic your brain. You will experience fear when the S&P500 is dropping 3% and you will experience fear of missing out when the S&P500 is gaining 3%. It is okay, but don’t trade on these emotions. Instead, focus on the long term and when you are in your twenties, the long term will be 40+ years.

Get your Investment Horizon clear

First of all, you should read a lot, but not about financial markets. Read about countries worldwide and how these intertwine, read about geopolitics and about sectors you are interested in. It is important that you form an opinion on all of these matters. Knowledge is power according to Littlefinger from Game of Thrones and it is true.

While you are reading, be aware that you are biased. You will form an opinion based on numerous of cognitive biases. Keep that in mind and try always to find the short story for your long story.

Subsequently, invest with a horizon of 40+ years in mind. Don’t try to be a smart guy that will beat every year the S&P500, but focus on diversification. Keep an eye on the short term developments of the sectors you are investing in, but do not let the daily stock price influence your long term goals. Time is your friend and compound interest will do the trick.

Compound interest

As I said before, the market is constantly changing their focus. The obvious reason is that the world is constantly changing as well. There will be numerous of times that the world is pessimistic and negative about the future. Wars will be fought and recessions will occur. It did happen in the last hundred years and will arise in the next hundred years.

However, the market showed some tremendous returns and it can show incredible returns in the hundred years to come. Nobody knows which portfolio fits you and which stocks you should buy. Nonetheless, with a balanced an diversified portfolio, compound interest will help you grow wealth.

People (in particular your non-financial environment) will not understand the power of compound interest. Our daily life is not functioning that way. That life wants to keep it simple: 9 hours of work, 8 hours of sleep and 2 pieces of fruit per day. It is hard to visualize. See in the chart below what happens if you reinvest your returns over 40 years with an investment of 100,000 euro and 7% annual return.

I want to end this post with Warren Buffet, one of the greatest long term investors of our time. He said in his latest letter (pdf) to the shareholders of Berkshire Hathaway the following about compound interest:

Let’s put numbers to that claim: If my $114.75 had been invested in a no-fee S&P 500 index fund, and all dividends had been reinvested, my stake would have grown to be worth (pre-taxes) $606,811 on January 31, 2019 (the latest data available before the printing of this letter). That is a gain of 5,288 for 1. Meanwhile, a $1 million investment by a tax-free institution of that time – say, a pension fund or college endowment – would have grown to about $5.3 billion.

Let me add one additional calculation that I believe will shock you: If that hypothetical institution had paid only 1% of assets annually to various “helpers,” such as investment managers and consultants, its gain would have been cut in half, to $2.65 billion. That’s what happens over 77 years when the 11.8% annual return actually achieved by the S&P 500 is recalculated at a 10.8% rate.


You can follow Unbreaking Wall Street via Twitter or through the newsletter (go to the top right to subscribe)

Powered by WordPress & Theme by Anders Norén