Friday, July 4, 2014

The Little Book of Behavioral Investing - Lessons Learned

I've been on a behavioral finance reading spree lately, consuming Inside the Investor's Brain (Richard Peterson), A Random Walk Down Wall Street (Burton Malkiel), and Behavioral Finance (William Forbes) in the last month. As much as I enjoyed those books, The Little Book of Behavioral Investing - How Not to Be Your Own Worst Enemy by James Montier was my favorite of the bunch. In a little over 200 pages, Mr. Montier went over many of the common mistakes/biases investors make, and suggested ways to over come them. A couple of my key take-aways are outlined below.

Less Information Is More
When looking at a public company as an investment opportunity, it's overwhelming to consider all the information available. Concentrating on a few key facts, such as yield, payout ratio, history of dividend increases, EPS growth, and P/E for a dividend investor yields far better results than trying to incorporate every piece of data available.

Focus on Facts, Not Stories
Just because a company has a great story, it doesn't mean the company is a great investment. Don't get me wrong, I enjoy hearing how Tesla is attempting to move consumers away from gas-guzzling cars, I wish First Solar lots of luck in installing solar solutions around the world, and I hope Go Pro can live up to the hype of their IPO, but I wouldn't invest in any of these companies. Their facts simply don't fit into my investment criteria, and I doubt they ever will.

There is Great Value in Doing Nothing
The media, the investment industry, and financial intermediaries all encourage investors to trade frequently to build wealth. Due to transaction costs, over-trading kills investment returns. Furthermore, investors suffer from biases of trading out of winners too soon, and holding onto losers. Unless there's a compelling reasons for me to trade, I'll simply sit on my investment portfolio, and invest new cash in the most promising investments.

It's All About the Investment Process
Mr. Montier encourages investors to focus on their investment process, as opposed to the outcomes. He suggests investors keep a trade journal (much like I've used this blog) to keep track of their process and how they came to their buy/sell decisions. Since the market is largely out of the investor's control, focusing on the process allows the investor to see flaws and correct them going forward. One particular lesson I learned in this area is to document my trade decisions when selling a winner. I fall into the group who sells winners too soon (i.e. Home Capital, Walgreens, Canadian Western Bank, etc.) and I have to figure out why I do that. Holding on will help my investment returns in the future.

The Little Book of Behavioral Investing has helped me see flaws in my investment process and thinking, and I'll be adding it to my permanent investing library. I'd encourage all serious, long-term investors to give Mr. Montier's book a thorough read. You'll be happy you did.

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