Saturday, April 19, 2008

Skepticism in Investing - How Much is Enough ?

This may seem a minor topic in investing; but it's something which has had me thinking some nights while lying in bed. Skepticism is a daily part of our lives when we encounter salespeople, financial planners and fund managers who try to sell us something we may or may not want. It's something inherent in human beings which help us to protect ourselves from getting fooled or swindled in this dog-eat-dog world. It has often been reported that the opposite of skepticism is called blind faith - trusting in something too much such that we are hoodwinked or blinded to its flaws.

How does this apply to investing ? I think skepticism should be a part of every investor, due to the fact that we have to read and digest mounds of information every day which may be coming at us from all angles. This makes it imperative to sieve out the important from the trivial, and to apply selective retention to ensure we do not get "flooded" by information which we may not need. Sometimes, articles and commentaries are written by certain celebrated people (also termed "gurus") which may comment on a specific trend, cycle, economic aspect or asset class. The prudent investor should exercise a certain degree of caution and a healthy dose of skepticism when reading such articles. This is because the writer may have been influenced by views culminated from other sources which he may have then incorporated into his own philosophy; or worse, there may be a hidden agenda behind what he says.

When I use the word "healthy dose", I am implying that one should, at the minimum, question certain facts and assumptions made by the writer and not blindly accept everything as the gospel truth. One can argue that one may not have the knowledge, experience or expertise of the writer but if one reads extensively enough, sooner or later one would be able to form opinions which may lend credence to what was read, or to counteract it. Skepticism is necessary in order for us to question the seemingly obvious; which in a way also contributes to our learning process and helps us to grow as individuals and as investors.

However, one must be wary of extreme skepticism, which is known as "cynicism". A cynic is a person who disbelieves or distrusts almost everything he reads as he thinks he either knows better or that everyone has a hidden agenda. This is skepticism taken to an extreme and is not healthy because cynicism causes one to reject ideas which may help to enhance knowledge, on the pretext that it cannot be true or there must be something more to it than meets the eye. Hence, I must advise all to have a healthy balance of skepticism and belief when reading and analyzing news reports or financials. This is especially applicable also to CEOs giving forecasts of radiant growth or commentators trying to determine if the market has topped or bottomed.

Add in a pinch of skepticism to your cup of knowledge, stir well and you will get a good mix of wisdom !

14 comments:

ThinkNotLeft said...

Hi Musicwhiz

An intriguing post. For more skepticism you may wish to read "Fooled by Randomness" and "The Black Swan"

Your post has also reminded me of why I decide not to buy First Ship Trust, despite its high dividends.

My reasons for not buying are a) not able to properly value First Ship Trust, b) FSL is likely to be less undervalued and more uncertain than Orchard Parade (based on my subjective FSL value vs OP reported estimated NAV) and c)lastly, I am neutral to dividends.

Cheers

Anonymous said...

hi battledome64 here,

Wondering if anyone know if Berlian Laju Debt problem might leak into FSL trust?

I am providing another perspective

Anonymous said...

Hey Musicwhiz,

Stumbled upon your blog today. Have to say its very good and very informative as well as educational. Novice investor here starting slow and small and reading all I can before dipping my feet into the stock market.

So far investments I made were in unit trusts. Thought of getting some cheap penny stocks?
Your thoughts on that?

Anyway I really like the sections on behavioral finance. Its really interesting and enlightening to learn more about an investor and the psychological forces behing each investor's mind.

Look forward to read more. Have added you on my fave list.

Cheers
Zazah

la papillion said...

Hi Zazah,

Erm you just started and you want to go into cheap pennies? I think you should read the behavioral finance part again :)

Things are cheap for a reason. Unless you have more compelling reasons to invest in a otherwise cheap counter, don't do it. The worst reason you can get into a stock is that it is cheap so you can own more of it.

Take care!

Anonymous said...

Hi La Papillon,

Thanks for the advice. Haha I'm very new to this. I read that maybe investing in the STI ETF is better for first timers. I don't know where to start but Im just reading and learning as I go. Blue chips are too expensive for me right now. guess I gotta save up more.

Regards
Zazah

la papillion said...

Zazah,

STI ETF is not too bad. It's a low cost fund with wide diversification. It will beat most funds hands down by taking a passive approach to 'own' the whole market.

Blue chips is expensive, but you can buy unit shares, so you won't have to buy 1 lot. 1 lot of DBS will cost you around $19k but 1 share is only $19. Check out POEMS share builder plan (SBP) if you like (check out only, dun buy). You might want to start saving first. Personally, I find that starting with around 10 to 20k of free savings is a good amt to start. But don't wait till you get that amount, you should start young and learn all the mistakes while you can take it :P

You'll never get younger than now, so seize the moment!

Investing in yourself is still the best investment :P

musicwhiz said...

Hi thinknotleft,

Thanks, I had seen those 2 books on shelves and know that they are pretty highly-acclaimed. Will get round to reading them eventually. :)

Your reasons for not purchasing FSL Trust are valid, as long as you feel you cannot properly value it. I have the same feeling for Babcock and Brown SFF even though some value investors say it is a good dividend investment; but to each his own I guess. Since you are neutral to dividends, that would definitely be another factor why FSLT is not attractive to you. For myself, I see it necessary to develop an income stream from my investments. :)

Regards,
Musicwhiz

musicwhiz said...

Hi battledome64 (long nick !),

So far the PT Berlian Laju problem was mentioned by FSLT management as merely a technical default and thus not as "serious" as it seems. Of course, whether FSLT Management is trying to cover something or not is unknown to me, but you are right to bring up the issue fo discussion. As far as I can report, I do not see any immediate counter-party risk arising (personal opinion).

Regards,
Musicwhiz

musicwhiz said...

Hello Zazah,

Thank you for reading and visiting. I certainly hope the sections on research, behavioural finance and investment mistakes can help new investors to make better decisions in terms of investing in companies.

Reading and educating yourself is always very important, and should come before you decide to put any money into the market. As for unit trusts, you can read my section on unit trusts to see why I do not think they are attractive.

My advice is not to punt on penny stocks as most of them are penny for a good reason. Research into good companies and be willing to pay more for quality.

Regards,
Musicwhiz

musicwhiz said...

Hi LP,

Yes, thanks very good advice indeed ! I think ETF are a low cost way of benchmarking the index, if you are not too keen to do a lot of research. Investing in knowledge is also of paramount importance.

Regards,
Musicwhiz

Bullpit said...

musicwhiz,

you are pretty hardworking on your
blog. On skepticism, it is just a
defensive attiude or stance that
what we dont know well, we prefer
not to believe. i think a better
way to weight a pick on reward and
losses rather, for me, perhaps 30
facts and its ranking in important can control each share destiny, it
is the alway the comparsion of its
bargain pricing compared to other
and its fair price that make a great buy

musicwhiz said...

Hi bullpit,

Thank you for visiting.

I think most of us are skeptics by nature, because we are wary of the increasing amounts of marketing and promotions being thrown at the unwary consumer for all kinds of stuff, whether products or services. Hence, we are always on our guard so that we are not cheated. In this sense, financial education does play an important role to ensure we do not get swindled of our hard-earned money.

I think your methodology (based on weightage of factors) is a good one, very rigorous and objective. Of course, some subjectivity will still be involved in assigning "weights" to various aspects of a business but nevertheless it's a good model to follow. :)

Cheers,
Musicwhiz

Ricky said...

Hi MW,

How do i screen through the "bluer" companies locally and quickly find a handful of companies to research deeper into?

I find it rather tedious to check every single company's annual report from the SGX website.

Regards

musicwhiz said...

Hi Ricky,

Perhaps you can screen them using their size and also their industry. There is no surefire way to do this. Analyst reports can also give you some head start but remember not to trust them. Always do your own research.

Cheers,
Musicwhiz