Sunday, February 24, 2008

Investment Sins Part 3 - Vanity/Pride

As the saying goes: "Pride goes before a fall", and this means that one who is proud will eventually fall because of his over-inflated ego. This investment sin is a very intruiging one as it discusses one's ego and shows how it affects one's investment decisions and philsophy. Vanity is a direct result of pride and being vain in investing simply means that you start worshipping yourself as if you could do no wrong.

Surprisingly (or maybe unsurprisingly), a survey conducted shows that men have a higher tendency to show excessive pride and an inflated ego when dealing with investments, and this could stem from the proverbial "male ego" which makes men aggressive and "kiasu". The "must0win" mentality may translate into fierce (and misplaced) pride in one's investing acumen and lead to one's eventual downfall. Women may also be prone to this but the survey mentioned that it is to a lesser extent. I am not going to go into a debate of the sexes but just wish to highlight that there are subtle differences in the way that men and women invest which are central to the topic I am discussing in this post. Perhaps I will discuss the differences between male and female investors in a future, more detailed post once I have collected sufficient "evidence" to form a theory.

Basically, to elaborate on the sin of pride, we look towards investors who "have to be right", no matter what ! This is a sure sign of pride at work but it is hard to be objective about oneself, so most will not be able to see that they are blinded by their own narcissistic tendencies. Some investors may have hit it big once or twice with certain investments, and suddenly they feel they are experts in a particular industry or subject matter. There are also others who may feel over-confident in their "system" used to beat the market repeatedly and let down their guard, only to be proven wrong in a big way thus incurring significant losses.

The danger of this sin is that it is rather insidious and creeps up on one slowly. As one's wealth grows as a result of successful investing, one may get more and more proud of his accomplishments and feel "invulnerable". This is a danger signal and is the start of a downward spiral into vanity and excessive pride in one's abilities. There is a term for this kind of misplaced pride: HUBRIS. Hubris can blind an investor and cause him to behave irrationally.

Below are some examples which are highlighted in Mr. Maury Fertig's book regarding investing behaviours that are signs of hubris:-

1) Refusing to sell an investment because you cannot admit you made a mistake - This is a classic case of refusing to acknowledge mistakes, and is a value investing no-no as well.

2) Throwing good money after bad - This is an extension of point 1 above and as the investor feels he could NOT have made a mistake, decides to average down to prove his point. Unfortunately, it may be the case of throwing money down the drain as the company's fundamentals may be deteriorating. Thus, one has to objectively evaluate a company to see if the fall in price is a result of worsening fundamentals, or simply sentiment-driven.

3) Possessing an unbalanced portfolio - This actually means that you are over-concentrating your investments in one narrow area (e.g. retail companies or just oil and gas companies) which may not be a bad move assuming you know the inside out of the industry and the nitty-gritty details. But if one is suffering from hubris, he may THINK he knows a lot when he actually does not, and thus fails to properly diversify his investments. Only if one truly understands one's investments should one concentrate them, as even Warren Buffett mentions that diversification is a protection against ignorance.

4) Making esoteric investments or following an arcane strategy - Overly proud investors usually like to be the first (pioneer) to discover a new type of investment or to dip their foot in the latest hot fads to show that they are "up-to-date". This behaviour may backfire badly if insufficient research has been done or if he is just trying to be different from the crowd for the sake of it. Remember that investing is not about showing off one's style but to achieve personal goals of wealth and financial freedom.

Thus, the above illustrates what could happen if one was "infected" with hubris. I am sure that all of us, at some point in time, have been guilty of the above sin in one form or another. The important thing is to recognize the sin and take active steps to prevent it from recurring, and to correct the mistake if already made. Make a conscious effort to examine yourself and your investments objectively instead of letting ego and pride go to your head. In this way, we can be assured of investment success in the long run.


H said...

Thanks MW,

Happened to discuss this with someone some time back. Hubris is "teminal" hard to recover once a person contracts it, especially for people in leadership position.

Have you been to Fort Canning?

Looking at majestic trees hundred years of age can really make one marvel about creation. (and humble anyone haha).

There is a FOC performance in Fort Canning:

If you have not been to Fort Canning, maybe can "invest" some time there. Its such a wondeful --- deeply undervalue.


musicwhiz said...

Hi HH,

Thanks for the links, will check them out this weekend maybe :)