Are We Making The Same Investment Mistakes?

Too much faith in our abilities has already cost us a lot. Yet we are making the same mistakes again

Published: Apr 19, 2010 06:51:52 AM IST
Updated: Sep 18, 2010 01:30:02 PM IST

Ever wonder why some of your ‘certain’ investment winners turned into lemons? The answer is confidence has its quirks. While looking at the bright side of things is useful, there is an incredibly fine line between optimism and over-confidence. More often than not, investors have greater confidence in their abilities than is warranted. For instance, most professional investors place great faith in their ability to decipher patterns and exploit ‘themes’ rather than aim to ‘buy cheap and sell dear’. What could be the justification for the outlandish salaries they earn apart from superior stock selection skills? It is precisely this illusion of knowledge and control that fosters over-confidence.

Most investors are beguiled by the thought that knowing more leads to superior investment decisions — the illusion of knowledge. Most often, more information is not the same as better information. The ability to ‘hear the right signals’ amidst a deluge of noise is rare! Equally importantly, we succumb to the illusion of control — the frequent belief that we can influence things that we clearly can’t.

Jason Zweig identified five reasons why over-confidence leads to serial under-performance in his pioneering work, Your Money and Your Brain. First, we are reasonably objective in figuring out the odds with regards to how others might do at a given task. But when it comes to self-assessment, we tend to go completely overboard. Not surprisingly, we wind up taking risks that we regret at leisure. Second, we put too much trust in whatever is familiar with the result that we are consistently ‘blind-sided’ in such situations. Third, our flawed belief in the extent to which we control our destiny leads to complacent decisions and a lack of adequate planning. Even worse, it makes us freeze when we are surprised by an unanticipated outcome. Fourth, we trick ourselves into believing that we can predict the future. This is particularly bizarre given the random past track record of most individuals in this
respect. Quite often this malevolent virus — the hindsight bias — leads us to make dangerously big bets.

On other occasions, such as the financial Armageddon of 2008, we are predictably irrational and fail to capitalise on the opportunity of a lifetime! Fifth and finally, we hate to admit that we might be entirely clueless about something. Warren Buffett was spot on when he said: “What counts for most people in investing is not how much they know, but rather how realistically they define what they don’t know. An investor needs to do very few things right as long as he avoids big mistakes.” Better to let the self-esteem take a knock rather than the bank balance!

The upbeat attitude of the international investor vis-à-vis Indian equities could be fleeting if signs emerge that the Western economies are headed for a double-dip. A jobless recovery in the US is clearly a straw in the wind that has ill omens. What is most worrying, however, is the unanimous belief around the globe by policy makers that accepting pain and the need for radical surgery is not necessary as a pre-requisite for reviving economic growth on a sustainable basis. Closer to home, the obsession with cosmetic change like selling 10 percent of Coal India in an IPO or allowing foreign universities to set up shop in India wholly obfuscate the need for urgent action in areas such as primary health and education, the need to enhance agricultural productivity, move towards greater mobility in the labour market and substantively trim the fiscal deficit. As a forthright Yank remarked, “Feeling good ain’t the same as doing good.”

Indraprastha Gas (Rs 229) is one among very few attractively priced opportunities on offer. The company, which trades at 12 times FY11 earnings, combines the virtues of being a “utility” (predictable cash flow/margins, limited competition and a stable customer base) with remarkable capital efficiency (30 percent+ ROE) and above average growth prospects.

An idea that might well appeal to a smart four-year-old not yet familiar with investment jargon!

Disclosure: This column is neither an offer to sell nor solicitation to buy any of the securities mentioned herein. The author, a partner at Fortuna Capital, frequently invests in the shares discussed by him.

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(This story appears in the 30 April, 2010 issue of Forbes India. You can buy our tablet version from To visit our Archives, click here.)

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