When Investing, Bow To Process, Not Personality

It is human tendency to over-estimate our knowledge instead of under-estimating it. We also love to believe in stories and not data or probabilities. Similarly, when it comes to investing, many seek assurance in comforting views and not real data and actual drivers of asset prices or returns. Such an attitude towards one’s hard-earned money leads to errors and poor investment results. This series of articles will endeavour to share learnings on what can be best be called ‘thinking errors’.

In the words of Rolf Dobelli, an investor, and the author of ‘The Art of Thinking Clearly’, “if we could learn to recognise and evade the biggest errors in thinking – in our private lives, at work or in government – we might experience a leap in prosperity. We need no extra cunning, no new ideas, no unnecessary gadgets, no frantic hyperactivity – all we need is less irrationality.”

I have tried to apply Dobelli’s concepts in my personal investing habits, and to some extent, in decision making. Let’s start with the concept of the ‘Authority Bias’, even if that runs the risk of some of you not reading my next article.

Authority Bias: Clouding Independent Thinking

Our education and upbringing make us, by default, bow to authority, especially teachers or elders. There is, however, a fine line between being respectful and ignoring the virtue of independent thinking. Around us, the mark of authority is seen in the white coats of doctors and dentists, in badges for the military, and in ties and suits worn by corporate executives. In my field of investing, these come in the form of celebrated titles that people carry. Along with the authority and image of being an ‘expert’, come situations of turning into an astrologer, having to make forecasts and predictions.

Did ‘Experts’ See This Coming?

Let’s imagine we are back in the first quarter of 2008. At that point in time, India had solid data points like a strengthening rupee, 10 percent GDP growth rate, a surge in corporate profits. Several infrastructure themes were being discussed, cooperation between the BRICS nations was being conceptualised, and market returns from preceding five years was skyrocketing at 40 percent per annum. In fact, the Nifty had surged by a factor of seven times since the lows of 2003. Naturally, the expert stories were about the next decade belonging to emerging markets and India and China. Accordingly, they predicted fast growth and aggressive returns for such investments. However, the reality was far from such ideas.

Very soon, the global financial crisis hit the world and stocks everywhere, including India, fell by 50 percent. It took investors six long years to recover the capital invested. The ‘expert narrative’ eventually yielded 6.90 percent returns over the next 11 years.

Meanwhile, for an investor who had come to the party late, that is in October 2008, he started his investment journey with all the bad news and most experts emphasising on fixed income products to bring stability to portfolios and also for benefits from the lowering of interest rates in India and globally. That investor witnessed slowing GDP, volatile and slow earnings growth, multiple phases of interest rates fluctuations and currency weakness. And, yet he earned 17 percent returns in the next 10-and-a-half years.

While these are extreme data points, the real return an investor would eventually earn is somewhere in between. An investor or an expert who quietly submitted himself or herself to a disciplined approach of investing every month and stuck to that for over a decade would have earned around 12 percent on the Nifty.

So, what is the moral of the story? Time the market? No. The whole idea is to recognise that instead of being lazy and relying on some expert’s predictions, it’s better to learn some probabilities and range of returns and be prepared accordingly, for good as well as the tough times.

How Do We Apply This?

• First, acknowledge that most views and forecasts by experts can be fully discounted.

It is grandmother’s wisdom that we should invest in an asset class the way we would buy vegetables and not perfumes. Keep the margin of safety in place and invest aggressively in equity funds when headlines are bad and valuations low. On the other hand, be more conservative and choose asset allocation funds when all predictions are very optimistic.

• Second, avoid making decisions relying on long-range forecasts by experts.

Who knows what oil prices would be in ten years from now? Who knew Brexit would happen ten years ago? Who could have seen that Chinese equities made no money even though it was the fastest growing country on Earth? Instead, invest in an asset class on the basis of your time horizon, your ability to withstand fluctuations and valuations for that asset class.

• Third, seek experts who give you a balanced perspective.

Make them share with you their own framework for investment decision-making for different asset classes. Check their track record for predictions. In a world of making so many choices, start with the first easy choice, of choosing a good advisor who will help you reduce your thinking errors and increase your chances of success in investing.

Bow to process, not personality.

Kalpen Parekh is President at DSP Investment Managers.

The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its Editorial team.