Friday, April 04, 2008

Investment Sins Part 4 - Lust

In the fourth installment of the investment sins series (which is taken from the book "The 7 Deadly Sins of Investing" by Maury Fertig), we take a look at Lust. The word lust is defined as "to have a yearning or desire, have a strong and excessive craving". The important words to take note of within the definition are "excessive" and "craving". Lust essentially stems from uncontrolled desire for something which overrides normal judgement and thinking. In relationships, lust has been known to result in cases of marital breakups as third-parties come into the picture. Lust usually has a negative connotation associated with it which implies a loss of control over one's faculties or objectivity; thus succumbing to their object of desire.


So after the English lesson, how does this all tie in with investing ? In investing, lust can manifest itself in various ways. Some examples of different types of lust are provided in Mr. Fertig's book, and I will detail each one briefly with an example:-

1) Holding on to a beloved investment much too long - This is a fairly common phenomenon for many investors and occurs when an investment that used to be a high performer starts to exhibit signs of deterioration. Remember that share prices are correlated to the earnings of a company; thus if a company can manage to grow or maintain earnings consistently into the future, there is no danger of gradual share price erosion. This case arises when one can only see good years ahead for his investment and fails to realize that the company has lost its competitive edge or perhaps its product is now "commoditized". As a result, margins begin to erode and profit begins to decline, leading to a drop in the value of the company. The lustful investor mistakenly believes that Mr. Market is mis-pricing the value of the company and continues to hold on even though it may be clear that fundamentals are decaying. Eventually, the share price will end up as a mere shadow of its former glory and the investor will be sitting on substantial paper losses; his dream and bubble pricked as if a child had pricked a balloon.

2) Becoming infatuated with an investment's surface looks and buying too soon - This is actually also a sign of sloth (not doing enough research) which I shall touch upon in a later part of this investment sins series. When one does not assess the risk/reward ratio of a potential investment and is attracted merely by the "sales talk", then it is also a sign of lust. Lusting after attractive products that is ! Most fund managers and those in the business of promoting alternative investments such as wine investing and land banking will come up with elaborate brochures (wuth large font sizes) as well as a mountain of positive data to support their claims of exceptional returns. It is all part of the sales tactics used by such individuals to generate more revenue and fees for their company. While I am NOT saying that all such investments are bad and that the salespeople are trying to con, one must be ever wary of tactics which may create an image of good returns while masking the true returns for an investment product. Sometimes, people may be lying by not telling the whole truth; or it may be a grey area. As an investor, we should NOT be too turned on by a product which appears to be appealing (and which seems to attract many "prominent" clients) and to compromise on your criteria for investing.

3) Developing an obsession with Plain Jane investments - This essentially means that one can lust after less "risky" investments in money-market funds which typically pay only about 1-2% return per annum; not even enough to cover out high inflation rate of 6.5%. Some people are obsessed with "safety" and refuse to place their money in unit trusts or equity markets for fear of losing everything; they thus become a lustful victim of the fallacy that fixed income securities are always "safer". On the contrary, being paid 1-2% by the bank or fund while inflation is 6.5% means that the real rate of return is a negative 4.5% (at best); thus your money is eroding away even as you feel secure that it is "safe". I have seen this happen with some of my friends and have been advising them to at least consider an index fund which gives market rates of return; instead of leaving their money in a fixed deposit (current rates are about 1.7% for 24 months and 1.9% for 36 months, and your money is locked in).

4) Lusting after gurus or certain fund managers - This is a particularly dangerous form of lust which involves the worship of one or more "gurus" who seem to know all about how markets move and what is best to invest in at any given point in time. There will always be talking heads on television and the news proclaiming that bear markets have arrived, we are in a recession or that commodities will enjoy a 10-year bull run. The lustful investor will latch on to one particular guru whom he/she adulates, and follow his/her recommendations blindly and without thinking. This can result in a lot of bad decisions beause failure to think about your investments usually gets one into big trouble. Thus, do NOT lust after a particular celebtiry (no matter how influential he may be). Instead, use your own logic and objective thinking and avoid those lustful thoughts !

In the next segment on investment sins, I will be touching on Avarice or Greed; one of the most pervasive investment sins ever !

12 comments:

Simon said...

i know this is completely irrelevant. but i realised amazon.com sells much cheaper finance books than even berkshire! thx to the depreciating USD. go check it out!
shipment is only 5usd per book and 5usd per shipment. counting all these in, it's actually still cheaper if u buy just more than 1 book.

la papillion said...

Hi Simon,

Really? oh my, have you tried it before? How long does it take? I've tried berkshire before, and usually if the book is in store, i can get it pretty fast, within 1 week at most.

Thks for the info!

musicwhiz said...

Hi Simon,

Yeah quite off-topic lor, but thanks for the tip nonetheless ! How about sharing some of your experiences with investment sins such as Lust ?

Regards,
Musicwhiz

musicwhiz said...

Hi LP,

Wah, this is value hunting indeed ! Looking for cheap books over the Internet. Usually I just use the nearest book-store, but I make sure got store-wide discount first. Hehe..

Cheers,
Musicwhiz

Simon said...

since it's overseas, the shipping takes about 4 wks. ive just bought a few books. should be arriving next month. i don't mind the wait, not in a hurry anyway. it's even cheaper after the berkshire discount!
go check it out. Let's say 'common stocks, uncommon profits' is only USD13.5+5(shipping)! There is an additional shipping cost of USD5, but u can always order more than 1 book to reduce the cost per item.

depreciating USD and bad business in US = good bargain for ppl in sg. =)

PanzerGrenadier said...

Dear Musicwhiz

I too have committed the sin of "Plain Jane"investments before I decide to take control of my own personal finance and start to take risks.

So far, my good performers are all outside the realm of what I would have invested 5 years ago...

Be well and prosper!

la papillion said...

Hi all,

Just 2 years ago, my riskiest investment is just POSB savings account :) Then I swung the other way into warrants and high risk companies, and now I swing back into more 'sane' investments :)

Hhaa, all part of the journey :)

Vincent said...

I confess im guilty of price anchoring (concept by the economist Richard Thaler), driven by greed of quick returns.

Anchoring means that we tend to be easily attached to a price/number that we see or hear.

Went into day trading with warrants, and was fixated at a certain price target that i "knew" (better) it had never gone below. Thought i had bought at a discount but tanked after underlying went down.

Quite a psychological turmoil there..

musicwhiz said...

Hi Simon,

Thanks for the info. I will remember this method of getting good books the next time I plan a buying spree ! But from what you said, 4 weeks is a pretty long wait...hehe.

Regards,
Musicwhiz

musicwhiz said...

Hi Panzer,

Glad you took the plunge and moved away from "Plain Jane" investments ! All the best for your investments !

Regards,
Musicwhiz

musicwhiz said...

Hi LP,

Yes it would seem there are 2 extremes: either the "safe" person who leaves his money in POSB or FD and earns paltry interest; or the high-risk gambling trader who trades frenetically by the minute. The first method does not beat inflation, so the value of money erodes over time; the second method can lead to financial suicide if one is not careful and disciplined enough and thus should not be encouraged.

All part of the journey yep, but it's good to learn from others so we do not repeat THEIR mistake. I see it more as you do not need to try something bad to know it's bad (e.g. you don't have to ingest heroin to know it's BAD for you). Thus, I have never touched warrants and do not have the intention to.

Regards,
Musicwhiz

musicwhiz said...

Hi Vincent,

Yes anchoring is another aspect of behavioural finance. As far as I know, day trading with warrants is highly risky and can result in significant losses. It is a practice I will strongly discourage.

Regards,
Musicwhiz