Decision Making
Investing is all about making choices!
Decision making lies at the heart of value investing. Since what is buying and selling stock all about if it is not about making choices?
How I make decisions determines my ability to be a successful investor. So I consider it important to have an understanding as to whether the way I make investment choices are potentially rewarding from a financial standpoint.
The psychology of decision making can be informed by behavioral finance which suggests that investors do not follow a rational decision making process as traditional finance theory makes out.
And when confronted with complex tasks, we humans also rely on our gut feelings or intuition and invoke rules of thumb that attempt to hit on the most important financial information to make investment decisions - and ignore the rest.
Some of us prefer not to make choices in isolation and do out decision making in groups. Investment clubs are one way people can undertake collective decision making.
So when considering a stock investment, there are a number of ways one can react. These can be considered in terms of some combination of READY-SET-GO.
Ideally, I try to get READY by researching the universe of stocks, narrowing the field by eliminating particular types as outlined in the choosing good stocks section, and using a stock screener to narrow the field further.
I get SET by including the limited number of 'best businesses' in a watch list and I GO to make a purchase of one or more from the list when a margin of safety appears for that particular stock.
That is, the price of the stock drops well below my estimate of its intrinsic or true value.
Of course, this does not happen too often. As I am not the only one who thinks they can sniff out a good business!
In the real world, pressures can arise that distort what I consider to be my ideal approach. The most common pressure arises from FEAR!!!! - the fear that occurs when markets tumble.
In this situation, I chant the Buffett mantra ...
BE BRAVE WHEN OTHERS ARE FEARFUL!
BE BRAVE WHEN OTHERS ARE FEARFUL!
And repeat it the required number of times!
Otherwise, my ideal READY-SET-GO quickly becomes READY-SET-READY-SET-READY-SET ...
And I tell myself that this procrastination or dilly-dallying is deadly to my long-term aim of above average returns on the portfolio.
Of course, this READY-SET-READY-SET -READY-SET ... can also occur at the top of the market cycle when I need to chant the alternative Buffett mantra ..
BE FEARFUL WHEN OTHERS ARE BRAVE!
BE FEARFUL WHEN OTHERS ARE BRAVE!
... and I should be commencing to do partial sell-offs of overvalued stocks as per my selling policy, rather than worrying about whether I am going to miss out on some extra bucks if the market trends higher.
Being fearful at the top of the market is just as important as being brave at the bottom end.
If I do not start selling off overvalued stocks before the downturn then I will not have the cash available to pick up the bargains at the bottom.
Of course some people are READY-READY-READY'ers because they can never get too much information and as a result can never get SET. Fortunately I am not one of those!
Also, many of us are tempted to be a GO-GO-GO'er when the market, or a particular sector, takes off. This is the root cause of stock market bubbles that we all know lead to the inevitable crash.
In this case there is no READY. People are going in blindly without doing their homework and considering the true value of the stock that they are speculating with.
The above two types of decision making are what I would call examples of poor decision making.
In the final analysis, this discussion on making good choices in your investments is about knowing yourself. Your nearest and dearest may be able to assist in this regard and act as critical friends - hopefully constructive ones!
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