“All men’s miseries derive from not being able to sit in a quiet room alone.” ~ Blaise Pascal
One of the many investing mistakes I made during the early part of my investing career was to be rash with cash.
Any extra cash I ever had was immediately invested in the stock market. Cash in bank was considered a wasted opportunity and every chance to “let-me-buy-stocks-now” was grabbed upon.
In the pre-2008 period, I invested a lot of the cash while keeping my eye on stock prices that were rising incessantly.
I see a lot of investors making a similar mistake now.
After getting frustrated by the way stock prices have performed over the past few years, any stock market rise is first disbelieved and then when prices rise further, people jump in so as to not miss out on any further rise.
This is a typical stage in a stock market cycle – disbelief followed by late acceptance, which is followed by a rush to invest in a hush – only that we are seeing this frequently off late.
Just consider the sharp surge in stock prices over the past four months. Several stocks have risen by 80-100%, and I see a lot of oohs and aahs from people who either did not buy during that period, or bought too less to make any difference to their portfolios.
Just read through the Comments in my recent post on investing mistakes in 2013 , and you would understand where I’m coming from.
Now, as we move ahead in 2014, I see two big dangers these investors – who are feeling left out – face…
- Regret Aversion Bias
- Anchoring Bias
See these two charts and you would understand why I’m talking about these two specific biases.
These charts assume that you are eyeing a stock that has risen sharply in price over the past few months and what you may end up doing seeing its performance over the next few months…
Now, the real danger you face in these two situations is not in buying the stock, but in buying it just because you…
- Resent not buying it earlier and don’t want to get into the same situation again; and
- Worry that the stock may rise even further and you don’t want to regret later if it really does.
Buying a stock out of resentment or worry and irrespective of the business’s intrinsic value is the real danger at all times, but more so in the current times when you may be suffering from an overdose of resentment and worry.
How to Lose Big Money in Investing
Charlie Munger once quoted Jesse Livermore as saying, “the big money (in investing) is not in the buying and selling but in the waiting”.
Inverting this, we get – “The big money (in investing) is lost not in waiting but in buying and selling.”
Hyper-activity is a big killer of investment returns. The business of constantly being in search of new stocks, reading daily news events and watching stock prices move around every day can create the feeling that you should take action more frequently than is warranted.
On the other hand, patience is a fundamental principle in achieving investment success.
It is important to have determined in advance exactly what companies you are interested in owning (by creating a watchlist of quality stocks ) and exactly what price would get your attention.
Then you wait and you watch.
Wait for the Fat Pitch
Charlie Munger says…
We have this investment discipline of waiting for a fat pitch. If I was offered the chance to go into business where people would measure me against benchmarks, force me to be fully invested, crawl around looking over my shoulder, etc., I would hate it. I would regard it as putting me into shackles.
Doing nothing – and holding on to cash – is a very hard thing for most people to do. People for some reason think there is a bonus of some sort for activity in investing when there most certainly is not.
In fact, there is a penalty on being overactive due to costs and expenses (trading commissions etc.).
That is what you must try to avoid – being overactive.
Set Klarman writes this in his paper – The Painful Decision to Hold Cash …
Few (investors) are able to look past near-term returns, and today anything appears to offer better returns than cash. Also, given their relative-performance-oriented, competitive nature, investors loathe the possibility of underperformance that comes from sitting on the sidelines; they find it better to be in the game (unless, of course, the market drops).
Most significantly, they remain highly skewed toward the greed end (how much can you make?) and away from the fear end (how much can you lose?) of the spectrum of investor emotions.
Betting that the markets never revert to historical norms, that we are in a new era of higher securities prices and lower returns, involves the risk of significant capital impairment. Betting that prices will fall at some point involves opportunity cost of uncertain amount. By holding expensive securities with low prospective returns, people choose to risk actual loss. We prefer the risk of lost opportunity to that of lost capital…
On the argument of whether an investor must hold cash or remain fully invested at all times, Klarman writes…
Some argue that holding significant cash is gambling, that being less than fully invested is akin to market timing. But isn’t a yes or no decision the crucial one in investing? Where does it say that investing means always buying something, even the best of a bad lot? An investor who can’t or won’t say no forgoes perhaps the most valuable tool available to investors.
Charlie Munger, Warren Buffett’s long-time partner, has counseled investors, “Look for more value in terms of discounted future cash flow than you’re paying for. Move only when you have an advantage. It’s very basic. You have to understand the odds and have the discipline to bet only when the odds are in your favor.”
Finally, to paraphrase Warren Buffett, ‘investing is like baseball; you are at bat waiting for a fat pitch that is in your sweet spot except in investing there are an unlimited number of pitches and no called strikes’.
The ability to do nothing and let the tough decisions go by is an intelligent investor’s advantage.
If you don’t have that ability – to do nothing and sit on cash when you don’t find opportunities – be ready to lose big money in 2014…and beyond.
P.S. On the question of where to park cash while waiting for opportunities, I do it in liquid/cash management funds, which offer me better interest rates (8-9%) than bank deposits (2-3%). Plus, when you keep cash in bank, you tend to waste it away.
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