Some people collect classic cars. Some people collect Chinese porcelain. I’m collecting mistakes. one’s own and another’s.
It can be jarring to learn how fallible we are. But errors help show us how our brains work. My purpose in writing this new column is to explore financial thinking, both good and bad, especially as it relates to investing.
The better you understand your mind, the easier it will be to avoid mistakes, especially the ones that cost you money.
Sometimes people make heroic blunders. In the 19th century, Germany traded control of the island of Zanzibar, a lucrative trading center, for the British-controlled Caprivi region, a remote corridor in central Africa. This linked the German colonialists in the southwestern part of the continent to the mighty Zambezi River. It was intended to give them a valuable trade route to the east coast.
Germany appears to have overlooked or underestimated Victoria Falls, 40 miles downstream. You wouldn’t want to take a steamboat over this 350-foot waterfall.
The strip’s namesake, the politician Graf von Caprivi, is now remembered primarily as a terrible deal-maker with an incredible mustache. His enthusiasm ran ahead of his knowledge.
The late decision-making guru Daniel Kahneman might have categorized Caprivi’s cock-up under the nimble heading, “What you see is all there is.”
This mistake occurs when we assume that the situation is completely defined by the limited information we have. For example, investors fall into this tendency when they imagine that the quantified part of a new corporate disaster is all there is to it.
This happens repeatedly. Lloyds said in 2011 that insurance misselling cost it £3.2 billion. The final bill to banks exceeded £20bn. When suspicions of money laundering were discovered at Danske Bank and Philips medical equipment broke down, initial cost estimates were too low.
Rex’s column, which I edited for several years as well as fellow FT Money columnist Stuart Kirk, pinpointed the shortfalls of Danish financiers and Dutch medical technology companies. In my previous role as a commentator for the City, I loftily suggested that Lloyd’s inflate its initial liability estimate so that it could later release reserves.
I’m reminded of that mistake every time the bank racks up another billion dollars in expected misselling costs. I have also made many mistakes as an individual investor. Here are four mistakes you’ll want to avoid repeating.
A plan to recover the implied price from a failed investment
In the early 2010s, I used my workplace savings scheme to buy shares in Pearson, which owned FT until 2015. I bought it for just over £12 a share because I believed, quite erroneously, that education was universally desired and that Pearson was uniquely equipped to provide it. . I sold it a few months ago for about £10.50.
Even in the narrow field of investing in multinational education companies, I hated selling below implied price because it meant locking in a loss and admitting I was a loser. It would have been better to think about investing in the round without ego and sell it sooner.
Think in terms of nominal prices
We could have joked that a loss of £1.50 per share wasn’t so bad if the dividend made up for it. But in real inflation-adjusted terms, it was down 14%, even including payments.
The only point of investing is to allow you or someone else to spend money on goods or services in the future. Therefore, the rate of return must be adjusted to account for the decline in the purchasing power of money. You also need to measure your portfolio’s performance against a low-risk benchmark.
buy high and sell low
No one does this intentionally. However, most individual investors do not participate or participate in the activities. We often arrive late to market festivals and wakes. Successful businesses and sectors have an attractive halo. Doom and cobwebs cling to underperforming companies and industries. Financial commentators also bear some responsibility.
When I confessed this to a former fund manager, he said: “Don’t worry, journalists naturally follow trends.” That made me feel better, but “trend followers” are woolly animals that run around in herds and lack basic survival instincts. I realized that it also refers to animals that have possessions.
One solution is to avoid “market timing,” where you try to buy low and sell high. However, this is much more difficult than it seems. Most of us invest our money in bulk and then withdraw it again in the same way. Even if you didn’t intend to do so, you’ll still be timing the market.
forced storytelling
Humans have an insatiable thirst for stories. Stories help us come to terms with a world where chaos reigns. But it’s easy to start building a story across the divide.
Showing the deceptive dignity of young people, I once wrote that there is no way the go-go Japanese stock market will collapse. I explained that the Treasury would never allow that. Tokyo stock prices officially halved in 1990, ushering in three decades of stagnation.
It is true that some countries in Asia have a more consensual culture than Western countries. It is not true that this would allow governments to determine stock prices.
I’m ignorant about important weird ideas. That’s to imagine I’d be the first to write about the economic aspects of it. Kahneman’s excellent 2012 compendium of cognitive biases, Thinking, Fast and Slow, includes many financial examples. Jason Zweig, an American personal finance guru, has written extensively on this subject. Writers dating back to Joseph de la Vega in 1688 have dissected the delusions that captivate investors.
The basic question is, “How can we learn from failure?” It has defined humanity ever since early humans stubbed their thumbs while making the first stone tools. In these FT Money columns, we hope to provide some fresh answers with the help of experts.
Jonathan Guthrie is a journalist, advisor and former head of the Lex column. Email: jonathanbuchananguthrie@gmail.com
