Cognitively Yours 1.1
"The mental short cuts are like back of envelope calculations and one has to the understand the limitations of these short cuts"
In the last blog, we had seen how we find things through mental short cuts-by trial and error leads people to develop rules of thumb and this results in errors. The mental short cuts are like back of envelope calculations and one has to the understand the limitations of these short cuts.
Why
investors have not done so well when the markets have done decently over the
last four decades. A passive investor would have got double digit returns by
investing in the index. One reason is that people are more sensitive to losses
than to absolutely commensurate gains.
The loss
has about a two and a half times the impact of a gain of the same magnitude.
This explains the reluctance of investors who refused to invest when the market
was down in the dumps a few months before. Investors were wary of entering the
market fearing further losses. Many investors fearing further downside exited
the market, thereby converting notional losses into permanent losses.
The fear of
equity has done more damage than the equity. In a fluctuating market, investors
find the pain of losses unbearable, exiting the category of asset class before
the benefits of equity become visible. So, when the market rallied
subsequently, many investors were ruing their decision to exit at an
inopportune time, which was known in hindsight.
The result
of this fear of regret makes investors
1. Invest solely in safe products that have
little to no interest and as time passes inflation reduces/eliminates one’s purchasing
power. The focus is only on eliminating risk rather than earning returns.
2. Not selling a stock that is below the price
you paid strictly because you do not want to take a loss. Loss is only when you
book it.
3. Selling a stock because it is greater than
the price you paid just to lock in the profits.
4. Not willing to change or content with the
status quo, as the regret of commission of an action is much more than the
omission.
Can relate to a few myself . Fell prey to this when I started this journey and still battling with this . How do you over come this ?
ReplyDelete...reliance on mental shortcuts and rule of thumbs leads to error...
ReplyDeleteThat is true and so does reliance on mathematical calculation of all probabilities .. Look at the recent example of Archego , vaporising into thin air. I don’t believe they relied on back of envelop or rule of thumbs.. they must have super computers at their disposal.
The essence of investing for future is its uncertainty. JP Morgan put it in nutshell when he said” No matter what you do capital is at risk. The right attitude would be to continually dealing with adverse outcomes.