Investor Psychology Quotes

Investing has the best results when you learn from nature.

Richard Feynman, the great physicist, once said, “Imagine how much harder physics would be if electrons had feelings.” Well, investors have feelings

Ultimately, Investing is about holistic ROI. It’s not about just owning stocks or crypto or flipping for quick income. When we talk about holistic ROI, we are looking at our long term profit, short term profit, income security, cash flow, social impact, environmental impact, spiritual impact, stability of the permaculture economy, and more. That’s how we see it at Mayflower-Plymouth.

Every tree in every forest is participating in investment activities….. capital allocation, energy flow, resourcefulness, utilization, leverage, information distribution, growth, value creation, and ROI…. Nature is an economy, and every tree is an investor in that economy. Sometimes I just sit in my back yard, observe, and take notes.

Man’s imperfect, limited-capacity brain easily drifts into working with what’s easily available to it. And the brain can’t use what it can’t remember or when it’s blocked from recognizing because it’s heavily influenced by one or more psychological tendencies bearing strongly on it … the deep structure of the human mind requires that the way to full scope competency of virtually any kind is to learn it all to fluency—like it or not.

Stock Traders are always trying to time the market. But an investor tends to be thinking bigger, more broadly, and more holistically.

The biggest investing errors come not from factors that are informational or analytical, but from those that are psychological. Investor

Irrational exuberance is the psychological basis of a speculative bubble. I define a speculative bubble as a situation in which news of price increases spurs investor enthusiasm, which spreads by psychological contagion from person to person, in the process amplifying stories that might justify the price increases and bringing in a larger and larger class of investors, who, despite doubts about the real value of an investment, are drawn to it partly through envy of others’ successes and partly through a gambler's excitement.

After spending years around investors and business leaders I’ve come to realize that someone else’s failure is usually attributed to bad decisions, while your own failures are usually chalked up to the dark side of risk.

We are not merely spectators of the world but investors in it,

As investor Michael Batnick says, "some lessons have to be experienced before they can be understood." We are all victims, in different ways, to that truth.

More than 2,000 books are dedicated to how Warren Buffett built his fortune. Many of them are wonderful. But few pay enough attention to the simplest fact: Buffett’s fortune isn’t due to just being a good investor, but being a good investor since he was literally a child. As I write this Warren Buffett’s net worth is $84.5 billion. Of that, $84.2 billion was accumulated after his 50th birthday. $81.5 billion came after he qualified for Social Security, in his mid-60s. Warren Buffett is a phenomenal investor. But you miss a key point if you attach all of his success to investing acumen. The real key to his success is that he’s been a phenomenal investor for three quarters of a century. Had he started investing in his 30s and retired in his 60s, few people would have ever heard of him. Consider a little thought experiment. Buffett began serious investing when he was 10 years old. By the time he was 30 he had a net worth of $1 million, or $9.3 million adjusted for inflation.16 What if he was a more normal person, spending his teens and 20s exploring the world and finding his passion, and by age 30 his net worth was, say, $25,000? And let’s say he still went on to earn the extraordinary annual investment returns he’s been able to generate (22% annually), but quit investing and retired at age 60 to play golf and spend time with his grandkids. What would a rough estimate of his net worth be today? Not $84.5 billion. $11.9 million. 99.9% less than his actual net worth. Effectively all of Warren Buffett’s financial success can be tied to the financial base he built in his pubescent years and the longevity he maintained in his geriatric years. His skill is investing, but his secret is time. That’s how compounding works. Think of this another way. Buffett is the richest investor of all time. But he’s not actually the greatest—at least not when measured by average annual returns.

What I am proposing here is that you consistently bet on inconsistency. What I am asking you to do is bet unfailingly on the failures of human reason, which is a sure bet indeed. It is a painful thing to admit that education, intellect and willpower are inadequate to make you the type of investor you would like to be, but it’s not as painful as losing money.

The idea that a few things account for most results is not just true for companies in your investment portfolio. It’s also an important part of your own behavior as an investor.

Most active investors fail to realize that they are part of the crowd themselves. They are trying to beat the crowd while being the crowd.

Think a little differently from the herd and see things they can’t or won’t.

This tendency of overconfidence and poor outcomes is not confined to only retail investors. Institutional investors suffer from overconfidence equally if not more, and their investment results are not superior either.

In a bubble, people demonstrate some sort of cult-like behavior. They defend their positions, not by economic logic, but by force. They do this by calling those who disagree with them dirty, and mocking people who give them prudent advice.

Mother Nature convincingly suggests that those who stay scared and run with the herd are more likely to stay alive. As investors around you behave irrationally and the news describes a miasma that will last for years, it’s easy to lose sight of your well-laid plans. It’s tempting to join the herd…

To limit the time resource applied to any one company, he reminds himself of psychological research which suggests that in many contexts decisions are best made with no more than five to seven points of information. Any more information beyond that does not significantly improve decisions, and may even degrade them.

A common adage on Wall Street is that the markets are motivated by two emotions: fear and greed. Indeed, this book suggests that investors are affected by these emotions. However, acting on these emotions is rarely the wise move. The decision that benefits investors over the long term is usually made in the absence of strong emotions.

Nassim Taleb writes in his book Fooled By Randomness: In Pharaonic Egypt … scribes tracked the high-water mark of the Nile and used it as an estimate for a future worst-case scenario. The same can be seen in the Fukushima nuclear reactor, which experienced a catastrophic failure in 2011 when a tsunami struck. It had been built to withstand the worst past historical earthquake, with the builders not imagining much worse—and not thinking that the worst past event had to be a surprise, as it had no precedent. This is not a failure of analysis. It’s a failure of imagination. Realizing the future might not look anything like the past is a special kind of skill that is not generally looked highly upon by the financial forecasting community. At a 2017 dinner I attended in New York, Daniel Kahneman was asked how investors should respond when our forecasts are wrong. He said: Whenever we are surprised by something, even if we admit that we made a mistake, we say, ‘Oh I’ll never make that mistake again.’ But, in fact, what you should learn when you make a mistake because you did not anticipate something is that the world is difficult to anticipate. That’s the correct lesson to learn from surprises: that the world is surprising.

A trader needs to be highly skilled and extremely lucky to beat the market consistently. If a trader is highly skilled but not lucky enough or extremely lucky but modestly skilled, he will beat the market occasionally but not consistently. Traders that are modestly skilled and modestly lucky will briefly beat the market but will be behind the market most of the time. Everybody else will lose money on a long-term basis, that is, 90% of the traders.

But even if you don’t have other offers or the interested buyer is your first choice, you have more power than before your counterpart revealed his desire. You control what they want. That’s why experienced negotiators delay making offers—they don’t want to give up leverage. Positive leverage should improve your psychology during negotiation. You’ve gone from a situation where you want something from the investor to a situation where you both want something from each other.

Does affirmative action place minority students in colleges where they're likely to fail while depriving other applicants of the chance to attend the most challenging schools where they are capable of succeeding? Does rent control drive up the cost of housing, depriving property owners of the same opportunity to profit as any other investor while driving down the quality and quantity of the housing stock? Do minimum wage laws reduce the number of entry-level jobs, making it harder to escape from poverty? Because compassion, by its nature, subordinates doing good to feeling good, these are questions the warm-hearted rarely pursue.

The modern capitalist economy must constantly increase production if it is to survive, like a shark that must swim or suffocate. Yet it’s not enough just to produce. Somebody must also buy the products, or industrialists and investors alike will go bust. To prevent this catastrophe and to make sure that people will always buy whatever new stuff industry produces, a new kind of ethic appeared: consumerism. Consumerism sees the consumption of ever more products and services as a positive thing. It encourages people to treat themselves, spoil themselves, and even kill themselves slowly by overconsumption. Frugality is a disease to be cured. Consumerism has worked very hard, with the help of popular psychology (‘Just do it!’) to convince people that indulgence is good for you, whereas frugality is self-oppression.

Women select short-term sexual relationships when men cannot improve their children’s survival, when there are too few men, or when their upbringing has signaled that men are unreliable investors in their progeny. Short-term relationships for women often amount to serial monogamy in response to a population of males, none of whom can or will provide sustained economic and emotional commitment. And if she can maintain her attractiveness in the face of her increasing age, decreasing looks, and the handicap (from a prospective partner’s viewpoint) of already born children, she can also gain the advantage of genetic diversity and perhaps better genetic quality in her children. But the most secure and stable route is to attract a male who will commit, providing the long-term assistance and resources that she needs to raise multiple offspring simultaneously. Unfortunately that idea has occurred to other women also and she is in a competitive market-place. The currency of the marketplace is what men want in a female partner. To trade successfully, she must advertise her assets by showing that she has more desirable qualities than her female rivals.

IRA funds became a form of play money for the middle class... Because the pool of capital that made up an IRA could not be withdrawn for twenty or thirty years, many people viewed their IRAs as containing money they could experiment with. They could use an IRA to buy their first stock or their first mutual fund. They could put in in a money market fund first, and then, as they got bolder - and the bull market became more irresistible - shift some of it into something a little riskier. IRAs gave people a way to try on the stock and bond markets for size, to see how they felt, and to become slowly comfortable with the idea of investing. The knowledge that the money couldn't easily be withdrawn acted as a psychological safety net, allowing investors to feel as though they could take a chance or two. If they made a mistake, they reasoned, there was still time to recoup - several decades, perhaps.Over time, many people came to believe that it as imperative to maximize the returns they were getting on their IRA account, even at the risk of taking a loss. How else would they ever have enough to retire on? This, surely, is the classic definition of investment capital.

But most investors do capitulate eventually. They simply run out of the resolve needed to hold out. Once the asset has doubled or tripled in price on the way up — or halved on the way down — many people feel so stupid and wrong, and are so envious of those who’ve profited from the fad or side-stepped the decline, that they lose the will to resist further. My favorite quote on this subject is from Charles Kindleberger: “There is nothing as disturbing to one’s well-being and judgment as to see a friend get rich” (Manias, Panics, and Crashes: A History of Financial Crises, 1989). Market participants are pained by the money that others have made and they’ve missed out on, and they’re afraid the trend (and the pain) will continue further. They conclude that joining the herd will stop the pain, so they surrender. Eventually they buy the asset well into its rise or sell after it has fallen a great deal. In other words, after failing to do the right thing in stage one, they compound the error by taking that action in stage three, when it has become the wrong thing to do. That’s capitulation. It’s a highly destructive aspect of investor behavior during cycles, and a great example of psychology-induced error at its worst.

A few years ago my friend Jon Brooks supplied this great illustration of skewed interpretation at work. Here’s how investors react to events when they’re feeling good about life (which usually means the market has been rising): Strong data: economy strengthening—stocks rally Weak data: Fed likely to ease—stocks rally Data as expected: low volatility—stocks rally Banks make $4 billion: business conditions favorable—stocks rally Banks lose $4 billion: bad news out of the way—stocks rally Oil spikes: growing global economy contributing to demand—stocks rally Oil drops: more purchasing power for the consumer—stocks rally Dollar plunges: great for exporters—stocks rally Dollar strengthens: great for companies that buy from abroad—stocks rally Inflation spikes: will cause assets to appreciate—stocks rally Inflation drops: improves quality of earnings—stocks rally Of course, the same behavior also applies in the opposite direction. When psychology is negative and markets have been falling for a while, everything is capable of being interpreted negatively. Strong economic data is seen as likely to make the Fed withdraw stimulus by raising interest rates, and weak data is taken to mean companies will have trouble meeting earnings forecasts. In other words, it’s not the data or events; it’s the interpretation. And that fluctuates with swings in psychology.

Putting it all together, fluctuations in attitudes and behavior combine to make the stock market the ultimate pendulum. In my 47 full calendar years in the investment business, starting with 1970, the annual returns on the S&P 500 have swung from plus 37% to minus 37%. Averaging out good years and bad years, the long-run return is usually stated as 10% or so. Everyone’s been happy with that typical performance and would love more of the same. But remember, a swinging pendulum may be at its midpoint “on average,” but it actually spends very little time there. The same is true of financial market performance. Here’s a fun question (and a good illustration): for how many of the 47 years from 1970 through 2016 was the annual return on the S&P 500 within 2% of “normal”—that is, between 8% and 12%? I expected the answer to be “not that often,” but I was surprised to learn that it had happened only three times! It also surprised me to learn that the return had been more than 20 percentage points away from “normal”—either up more than 30% or down more than 10%—more than one-quarter of the time: 13 out of the last 47 years. So one thing that can be said with total conviction about stock market performance is that the average certainly isn’t the norm. Market fluctuations of this magnitude aren’t nearly fully explained by the changing fortunes of companies, industries or economies. They’re largely attributable to the mood swings of investors. Lastly, the times when return is at the extremes aren’t randomly distributed over the years. Rather they’re clustered, due to the fact that investors’ psychological swings tend to persist for a while—to paraphrase Herb Stein, they tend to continue until they stop. Most of those 13 extreme up or down years were within a year or two of another year of similarly extreme performance in the same direction.

Too much optimism leads investors to underestimate risk and overestimate expected performance. Optimistic investors tend to seek good-story stocks and be less critical. Pessimistic investors tend to be more analytical. Extended,

Effect On Culture Organizations are made up of people. Those people work and “live” there with other people at least 40 hours per week. Like the connective tissue that begins to form when we are injured or when we are healing and becomes a part of who we are, team members are a part of the connective tissue of the organization. What happens when we remove or tear out a piece of that tissue? Not only does it hurt a lot, it causes heavy bleeding. If it doesn’t heal properly, there are complications. We may never regain our function in that area. When good productive people leave, we feel the pain and so does the culture of the team. The only way to mend the tissue permanently is to do the right things to engage and retain them. Spillover Effect We don’t talk about this much, but there is a psychological impact on other productive and engaged employees when they are forced to work with disengaged employees. Whether it is during water cooler talk or just in combined work spaces, the negative energy that disengaged employees pass to the entire team and organization can be toxic. Oftentimes, the disengaged employees are the scapegoats to deeper organizational issues. When we do not look at what is causing them to be disengaged, we enable the spillover effect to continue. Organizations that want a thriving workplace must rid themselves of disengaged employees, not necessarily by termination, but by living by the Laws found in this book. Negative Word Of Mouth Remember that unhappy employees don’t make for good promoters of your brand. In fact, disengaged employees are likely to tell more people and blurt it out all over social media and at every party. Reputationally, this negative word of mouth works against your brand promise. Who are you out in the world to your customers? Whatever that is, it must match who you are to your employees. Loss Of Organizational Stability Stop for a minute and think about what it says to your customers, partners, and investors when your employees keep walking out the door. Potentially, they could be in the middle of a complex project implementation and having a consistent point of contact through that process is key.

Their evidence supports life-cycle predictions that older investors hold less risky portfolios. They also show evidence that experience leads older investors to exhibit stronger preference for diversification, trade less frequently, exhibit greater propensity for year-end tax-loss selling, and exhibit fewer behavioral biases. Consistent with cognitive aging effects, they found that older investors exhibit worse stock selection ability and poor diversification skill. As investors both age and gain experience, their investment skill increases. Then, as cognitive aging begins, that skill starts to diminish, even while gaining more experience. The investment skill deteriorates sharply starting at the age of 70. The impact of the declining cognitive ability results in an estimated 3 percent lower risk-adjusted annual returns and that underperformance increases to over 5 percent among older investors with large portfolios. Thus, there are real economic consequences to cognitive aging.

Greed and fear rule the market. Share market is common sense and understanding of investor psychology and has nothing to do with head and shoulder patterns nor candlestick patterns or hockey stick chart or cup formation and so on and so forth.

I see the supposed convenience of being able to trade ETFs throughout the day as a psychological disadvantage. Unless you are able to predict intraday market moves—a fool’s errand if ever there was one—you are faced with the oftentimes paralyzing choice of exactly when to buy or sell.

Investor Trading Decision makers tend to place each investment into a separate mental account. Each investment is treated separately, and interactions are overlooked. This mental process can adversely affect an investor’s wealth in several ways. First, mental accounting exacerbates the disposition effect discussed in Chapter 3. Recall that investors avoid selling stocks with losses because they do not want to experience the emotional pain of regret. Selling the losing stock closes the mental account, triggering regret.

The tools of traditional finance, like modern portfolio theory, can help investors establish efficient portfolios to maximize their wealth with acceptable levels of risk. However, mental accounting makes it difficult to implement these tools. Instead, investors use mental accounting to match different investing goals to different asset allocations. This often leads to investors diversifying their portfolios by goal rather than in total. When investors pick investments in each goal-focused mini portfolio, they examine each choice’s individual risk and return characteristics and ignore their diversification characteristics. They eliminate the choices they view as inferior and then often simply divide their money equally among the acceptable choices.

Psychological research has shown that the brain uses shortcuts to reduce the complexity of analyzing information. Psychologists call these heuristic simplifications. These mental shortcuts allow the brain to generate an estimate of an answer before fully digesting all the available information. Two examples of shortcuts are known as representativeness and familiarity. Using these shortcuts allows the brain to organize and quickly process large amounts of information. However, these shortcuts also make it hard for investors to analyze new information correctly and can lead to inaccurate conclusions.

The brain often uses the familiarity shortcut to evaluate investments. This can cause people to invest too much money in the stocks that are most familiar to them, like their employer’s stock. Ultimately, this leads to a lack of diversification. In summary, investors allocate too much of their wealth to their employer, local companies, and domestic stocks.

Three scholars illustrate the role of intelligence in a data set of Finnish investors in which they have IQ information from prior (mandatory) military service.8 They find that the high IQ investors’ portfolios outperform the low IQ investors by 4.9 percent per year. This higher return stems from the higher IQ investors exhibiting better market timing and stock picking. In addition, they are less prone to the disposition effect and the sentiment of other investors.

When individual investors are optimistic, the demand for these funds increases and the discount declines. Pessimistic investors sell the funds, and the discount increases.

These results suggest that optimistic investors bid up speculative stocks to overvalued levels. When the optimism becomes high, so does the stock price. Eventually, the optimism reaches its peak. From these high levels, the stocks subsequently earn a lower return. Pessimistic investors avoid speculative stocks, which fall to a low level. As the sentiment gets more negative, stocks decline.

Psychologists have reported correlations between the full moon and depressed mood. If the lunar cycle impacts investors, then they may value stocks less during a full moon relative to a new moon, thus causing a lower return around the full-moon period.

Kahneman notes in his book on investor psychology, experience is not a very good teacher in investing and markets. 2 As human beings, we often extract the wrong lessons from past successes, don’t learn enough from our failures, and sometimes delude ourselves into remembering things that never happened.

It is not intuitive that an investor can be wrong half the time and still make a fortune. It means we underestimate how normal it is for a lot of things to fail. Which causes us to overreact when they do.

Jim Simons, head of the hedge fund Renaissance Technologies, has compounded money at 66% annually since 1988. No one comes close to this record. As we just saw, Buffett has compounded at roughly 22% annually, a third as much. Simons’ net worth, as I write, is $21 billion. He is—and I know how ridiculous this sounds given the numbers we’re dealing with—75% less rich than Buffett. Why the difference, if Simons is such a better investor? Because Simons did not find his investment stride until he was 50 years old. He’s had less than half as many years to compound as Buffett. If James Simons had earned his 66% annual returns for the 70-year span Buffett has built his wealth he would be worth—please hold your breath—sixty-three quintillion nine hundred quadrillion seven hundred eighty-one trillion seven hundred eighty billion seven hundred forty-eight million one hundred sixty thousand dollars.

Something I’ve learned from both investors and entrepreneurs is that no one makes good decisions all the time. The most impressive people are packed full of horrendous ideas that are often acted upon. Take Amazon. It’s not intuitive to think a failed product launch at a major company would be normal and fine. Intuitively, you’d think the CEO should apologize to shareholders. But CEO Jeff Bezos said shortly after the disastrous launch of the company’s Fire Phone: If you think that’s a big failure, we’re working on much bigger failures right now. I am not kidding. Some of them are going to make the Fire Phone look like a tiny little blip.

Most financial advice is about today. What should you do right now, and what stocks look like good buys today? But most of the time today is not that important. Over the course of your lifetime as an investor the decisions that you make today or tomorrow or next week will not matter nearly as much as what you do during the small number of days—likely 1% of the time or less—when everyone else around you is going crazy.

To grasp why people bury themselves in debt you don’t need to study interest rates; you need to study the history of greed, insecurity, and optimism. To get why investors sell out at the bottom of a bear market you don’t need to study the math of expected future returns; you need to think about the agony of looking at your family and wondering if your investments are imperiling their future.

Richard Feynman, the great physicist, once said, “Imagine how much harder physics would be if electrons had feelings.” Well, investors have feelings. That’s why it’s hard to predict what they’ll do next based solely on what they did in the past.

We call everyone investing money “investors” like they’re basketball players, all playing the same game with the same rules. When you realize how wrong that notion is you see how vital it is to simply identify what game you’re playing.

If you want to do better as an investor, the single most powerful thing you can do is increase your time horizon. Time is the most powerful force in investing. It makes little things grow big and big mistakes fade away. It can’t neutralize luck and risk, but it pushes results closer towards what people deserve.

History is mostly the study of surprising events. But it is often used by investors and economists as an unassailable guide to the future.

Stocks aren’t like a pair of shoes with a consistent value that you can buy on sale—the value of a business changes based on economics and its prospective earnings.

I am a passive investor optimistic in the world’s ability to generate real economic growth and I’m confident that over the next 30 years that growth will accrue to my investments.

The Intelligent Investor

investor Michael Batnick says, “some lessons have to be experienced before they can be understood.” We are all victims, in different ways, to that truth.

Spreadsheets can model the historic frequency of big stock market declines. But they can’t model the feeling of coming home, looking at your kids, and wondering if you’ve made a mistake that will impact their lives. Studying history makes you feel like you understand something. But until you’ve lived through it and personally felt its consequences, you may not understand it enough to change your behavior. We all think we know how the world works. But we’ve all only experienced a tiny sliver of it. As investor Michael Batnick says, “some lessons have to be experienced before they can be understood.” We are all victims, in different ways, to that truth.

The Intelligent Investor is one of the greatest investing books of all time. But I don’t know a single investor

The economists wrote: “Our findings suggest that individual investors’ willingness to bear risk depends on personal history.” Not intelligence, or education, or sophistication. Just the dumb luck of when and where you were born.

Bubbles form when the momentum of short-term returns attracts enough money that the makeup of investors shifts from mostly long term to mostly short term.

you want to do better as an investor, the single most powerful thing you can do is increase your time horizon. Time is the most powerful force in investing. It makes little things grow big and big mistakes fade away. It can’t neutralize luck and risk, but it pushes results closer towards what people deserve.

Investors often innocently take cues from other investors who are playing a different game than they are.

Take retirement. At the end of 2018 there was $27 trillion in U.S. retirement accounts, making it the main driver of the common investor’s saving and investing decisions.5 But the entire concept of being entitled to retirement is, at most, two generations old. Before World War II most Americans worked until they died. That was the expectation and the reality. The labor force participation rate of men age 65 and over was above 50% until the 1940s:

More than 2,000 books are dedicated to how Warren Buffett built his fortune. Many of them are wonderful. But few pay enough attention to the simplest fact: Buffett’s fortune isn’t due to just being a good investor, but being a good investor since he was literally a child.

Of all the unlikely people to get mixed up with Madoff’s Ponzi scheme, Stephen Greenspan is the type of person you’d expect to be immune to investment fraud. With advanced degrees from Johns Hopkins University, he spent his career as a clinical professor of psychiatry at the University of Colorado studying social incompetence and gullibility. At the time of his retirement, Greenspan had published nearly 100 scientific papers and was well-known in psychology for his book Annals of Gullibility. With interest and expertise in the science of gullibility, shouldn’t Greenspan have recognized that Madoff’s firm was a scam? Yet he too was one of BLMIS’s private investors.

As investor Michael Batnick says, “some lessons have to be experienced before they can be understood.

More importantly, the value of wealth is relative to what you need. Say you and I have the same net worth. And say you’re a better investor than me. I can earn 8% annual returns and you can earn 12% annual returns. But I’m more efficient with my money. Let’s say I need half as much money to be happy while your lifestyle compounds as fast as your assets. I’m better off than you are, despite being a worse investor. I’m getting more benefit from my investments despite lower returns.

I can afford to not be the greatest investor in the world, but I can’t afford to be a bad one. When I think of it that way, the choice to buy the index and hold on is a no-brainer for us.

The Intelligent Investor,

They say that the biggest opportunities are often outside of most people’s comfort zones. The juiciest market returns are where very few are willing to go. Momentum investing is the ultimate contrarian approach. How many investors would venture to buy a stock that is already up 50% in the past six months? Psychologically, it is a lot harder to buy in this situation than to sell, isn’t it?   How ridiculous does it sound that stocks that went up 50% in the past six months are likely to outperform in the next six months? Stock picking cannot be that easy, right? There has to be some complicated formula that takes into account hundreds of different criteria in order to have a chance at outperforming the market. Sometimes the most effective methods are the simplest. Most people stay away from them exactly because they seem too simple to work. There is nothing magic about using past performance to select future winners. It is all about simple math.   What

In April, 1926, France and the United States finally negotiated a war debt settlement at forty cents on the dollar. The [French] budget was at last fully balanced. Still the franc kept falling. By May, the exchange rate stood at over thirty to the dollar. With a currency in free-fall, prices now rising at 2% a month - over 25% a year - and the Government apparently impotent, everyone made the obvious comparison with the situation in Germany four years earlier. In fact, there was no real parallel. Germany in 1922 had lost all control of its budget deficit and in that single year expanded the money supply ten fold. By contrast, the French had largely solved their fiscal problems and its money supply was under control. The main trouble was the fear that the deep divisions between the right and left had made France ungovernable. The specter of chronic political chaos associated with revolving door governments and finance ministers was exacerbated by the uncertainty over the governments ability to fund itself given the overhang of more than $10 billion in short term debt. It was this psychology of fear, a generalized loss of nerve, that seemed to have gripped French investors and was driving the downward spiral of the franc. The risk was that international speculators, those traditional bugaboos of the Left, would create a self-fulfilling meltdown as they shorted the currency in the hope of repurchasing it later at a lower price thereby compounding the very downward trend that they were trying to exploit. It was the obverse of a bubble where excessive optimism translates into rising prices which then induces even more buying. Now excessive pessimism was translating into falling prices which were inducing even more selling. In the face of this all embracing miasma of gloom neither the politicians nor the financial establishment seemed to have any clue what to do.

In How Markets Fail, John Cassidy describes classic psychology experiments conducted by Swarthmore’s Solomon Asch in the 1950s.

The reality of risk is much less simple and straightforward than the perception. People vastly overestimate their ability to recognize risk and underestimate what it takes to avoid it; thus, they accept risk unknowingly and in so doing contribute to its creation. That’s why it’s essential to apply uncommon, second-level thinking to the subject. Risk arises as investor behavior alters the market. Investors bid up assets, accelerating into the present appreciation that otherwise would have occurred in the future, and thus lowering prospective returns. And as their psychology strengthens and they become bolder and less worried, investors cease to demand adequate risk premiums. The ultimate irony lies in the fact that the reward for taking incremental risk shrinks as more people move to take it.

Investment markets follow a pendulum-like swing: • between euphoria and depression, • between celebrating positive developments and obsessing over negatives, and thus • between overpriced and underpriced. This oscillation is one of the most dependable features of the investment world, and investor psychology seems to spend much more time at the extremes than it does at a “happy medium.

Believe me, there’s nothing better than buying from someone who has to sell regardless of price during a crash. Many of the best buys we’ve ever made occurred for that reason. A couple of observations are in order, however: • You can’t make a career out of buying from forced sellers and selling to forced buyers; they’re not around all the time, just on rare occasions at the extremes of crises and bubbles. • Since buying from a forced seller is the best thing in our world, being a forced seller is the worst. That means it’s essential to arrange your affairs so you’ll be able to hold on—and not sell—at the worst of times. This requires both long-term capital and strong psychological resources.

What weapons might you marshal on your side to increase your odds? Here are the ones that work for Oaktree: • a strongly held sense of intrinsic value, • insistence on acting as you should when price diverges from value, • enough conversance with past cycles—gained at first from reading and talking to veteran investors, and later through experience—to know that market excesses are ultimately punished, not rewarded, • a thorough understanding of the insidious effect of psychology on the investing process at market extremes, • a promise to remember that when things seem “too good to be true,” they usually are, • willingness to look wrong while the market goes from misvalued to more misvalued (as it invariably will), and • like-minded friends and colleagues from whom to gain support (and for you to support).

Would-be investors can take courses in finance and accounting, read widely and, if they are fortunate, receive mentoring from someone with a deep understanding of the investment process. But only a few of them will achieve the superior insight, intuition, sense of value and awareness of psychology that are required for consistently above-average results. Doing so requires second-level thinking. Remember, your goal in investing isn’t to earn average returns; you want to do better than average. Thus, your thinking has to be better than that of others—both more powerful and at a higher level. Since other investors may be smart, well-informed and highly computerized, you must find an edge they don’t have. You must think of something they haven’t thought of, see things they miss or bring insight they don’t possess. You have to react differently and behave differently. In short, being right may be a necessary condition for investment success, but it won’t be sufficient.

From a psychological point of view, the POD occurs when a hot-stock high-flyer breaks down severely, at which point it is able to bring in investors who missed the prior big price run and see the stock as “cheap.” This sets off a very rapid price advance back up to the highs and the left side of the POD that is quite simply unsustainable. At that point, everyone who is going to buy the stock has, and the sellers who hit the stock at the left side peak of the POD can now finish distributing their stock. With fewer “suckers” left to buy it, the stock then breaks down in rapid fashion and in most cases to new lows.

It is not intuitive that an investor can be wrong half the time and still make a fortune. It means we underestimate how normal it is for a lot of things to fail.

To grasp why people bury themselves in debt you don’t need to study interest rates; you need to study the history of greed, insecurity, and optimism. To get why investors sell out at the bottom of a bear market you

investor, the single most powerful thing you can do is increase your time horizon. Time is the most powerful force in investing. It makes little things grow big and big mistakes fade away.

Go out of your way to find humility when things are going right and forgiveness/compassion when they go wrong. Because it’s never as good or as bad as it looks. The world is big and complex. Luck and risk are both real and hard to identify. Do so when judging both yourself and others. Respect the power of luck and risk and you’ll have a better chance of focusing on things you can actually control. You’ll also have a better chance of finding the right role models. Less ego, more wealth. Saving money is the gap between your ego and your income, and wealth is what you don’t see. So wealth is created by suppressing what you could buy today in order to have more stuff or more options in the future. No matter how much you earn, you will never build wealth unless you can put a lid on how much fun you can have with your money right now, today. Manage your money in a way that helps you sleep at night. That’s different from saying you should aim to earn the highest returns or save a specific percentage of your income. Some people won’t sleep well unless they’re earning the highest returns; others will only get a good rest if they’re conservatively invested. To each their own. But the foundation of, “does this help me sleep at night?” is the best universal guidepost for all financial decisions. If you want to do better as an investor, the single most powerful thing you can do is increase your time horizon. Time is the most powerful force in investing. It makes little things grow big and big mistakes fade away.

A rational investor makes decisions based on numeric facts. A reasonable investor makes them in a conference room surrounded by co-workers you want to think highly of you, with a spouse you don't want to let down, or judged against the silly but realistic competitors that are your brother-in-law, your neighbor, and your own personal doubts. Investing has a social component that's often ignored when viewed through a strictly financial lens.

Warren Buffett and George Soros eschew derivatives. Hedge fund managers bet against the Wall Street banks that develop complex products. The best investors – today and yesterday – make money not because they understand abstruse mathematical models, but because they have a deep intuition about the timing and machinations of financial markets. Markets have been complex for a long time, and their ebbs and flows always have depended, not only on intricate disclosures about assets and liabilities, but also on human psychology. That has not changed since the 1920s.

To get why investors sell out at the bottom of a bear market you don’t need to study the math of expected future returns; you need to think about the agony of looking at your family and wondering if your investments are imperiling their future.

As investor Michael Batnick says, “some lessons have to be experienced before they can be understood.” We are all victims, in different ways, to that truth.

Few investors have the disposition to say, “I’m actually fine if I lose 20% of my money.” This is doubly true for new investors who have never experienced a 20% decline. But if you view volatility as a fee, things look different. Disneyland tickets cost $100. But you get an awesome day with your kids you’ll never forget. Last year more than 18 million people thought that fee was worth paying. Few felt the $100 was a punishment or a fine. The worthwhile tradeoff of fees is obvious when it’s clear you’re paying one. Same with investing, where volatility is almost always a fee, not a fine. Market returns are never free and never will be. They demand you pay a price, like any other product. You’re not forced to pay this fee, just like you’re not forced to go to Disneyland. You can go to the local county fair where tickets might be $10, or stay home for free. You might still have a good time. But you’ll usually get what you pay for. Same with markets. The volatility/uncertainty fee—the price of returns—is the cost of admission to get returns greater than low-fee parks like cash and bonds. The trick is convincing yourself that the market’s fee is worth it. That’s the only way to properly deal with volatility and uncertainty—not just putting up with it, but realizing that it’s an admission fee worth paying. There’s no guarantee that it will be. Sometimes it rains at Disneyland. But if you view the admission fee as a fine, you’ll never enjoy the magic. Find the price, then pay it.

Investor Bill Mann once wrote: “There is no faster way to feel rich than to spend lots of money on really nice things. But the way to be rich is to spend money you have, and to not spend money you don’t have. It’s really that simple.”31

A trap many investors fall into is what I call “historians as prophets” fallacy: An overreliance on past data as a signal to future conditions in a field where innovation and change are the lifeblood of progress.

Stanford professor Scott Sagan once said something everyone who follows the economy or investment markets should hang on their wall: “Things that have never happened before happen all the time.” History is mostly the study of surprising events. But it is often used by investors and economists as an unassailable guide to the future.

The reasonable investors who love their technically imperfect strategies have an edge, because they’re more likely to stick with those strategies.

If investors do not know or never attempt to know the fair value, they can pay any price. More often, the price they pay is far greater than the actual value.

simplicity of choice, and promise of satisfactory results, in terms of psychology as well as arithmetic.

Individual investors have significant advantages over professional money managers. Retail investors, like you and I, have nobody to report. We have no benchmark to beat and have no fear of capital flight. There are no quarter and year ends, and performance is not linked to calendars.

The market’s long-term trajectory is upward, which is the only direction the market can go over a long period.

All capital investments inherently suffer the risk of permanent capital loss. As an investor, it is your job to differentiate between market volatility and a permanent capital loss. You can only achieve this when you fundamentally understand why you bought the asset in the first place.

Bubbles do their damage when long-term investors playing one game start taking their cues from those short-term traders playing another.

Investors often regret the actions they take, but seldom regret the ones they do not.