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Unnecessary Risks and Why Some People Always Lose Money

Why Some People Always Lose Money


Do you like taking unnecessary risks? With money? I am not sure about your answer but mine is that I don’t.

Ofcourse we cannot eliminate the risks in stock market investing. But lower the risks are, better I feel. In previous post about why being smart is not necessary to be rich, I explained why having a super IQ + intelligence might not protect your investments.
 
We need to understand that we can afford not to be a great investor. But we cannot afford to be a bad one.

The downside of being bad are pretty, bad. There is no need to take unnecessary risks if you don’t know what exactly is being offered in a deal. You can always choose to walk out of a deal you don’t understand fully. Instead, take the 2nd best strategy if that works for you more than the best one. 
 
I know many cases where people have lost all money in stock markets. Then there are those who are waiting to recover money lost in stocks, even after years (and in rare cases, decade). Even the financial companies at times (rather most of the times) try to fool you. Read thisfor a real-life incident.
 
And who can forget the IPOs? Designed specifically to not-benefit only one category of people – new investors. 🙂

The promoters know more about their companies than the small investors. They only come out with IPOs when they know that they will be able to sell at prices, which are higher than actual intrinsic value. Now when the prices correct in line with actual value, the small investors get hurt. Then promoters come back with buybacks, open offers and delisting proposals. So all in all, its quite unfair. But people still take the IPO route when they see any recent trend of IPOs doing well.
 
In secondary markets, most investors participate with the wrong mentality. With share prices going up and down on a daily basis, there is an urge to act and benefit from volatility. But most investors lack the capability to make the right decisions under such levels of uncertainty. They let emotions take control of their portfolio and end up ruining it.

Another reason why some people always end up losing money is that they bet something important to get something unimportant.
 
Lets take an example.
 
Suppose you have to send your child to college in 5 years. You know that you will need Rs 15 lacs for that after 5 years. You have already saved up Rs 10 lac and are also regularly saving Rs 7000 a month. This will easily let you achieve the target of Rs 15 lacs in 5 years, even if you don’t earn anything on Rs 10 lac that you have already saved .
 
But your high-flying, high IQ financial advisor tells you that a particular sector is expected to do well in coming years. And you can benefit from this once-in-a-lifetime-opportunity by investing in some sectoral fund. You think about it and invest the already accumulated Rs 10 lacs in the sector fund.

Unfortunately, the sector doesn’t turn out to be a once-in-a-lifetime-opportunity and your investment goes down to Rs 7 lacs after 5 years.
 
Result is that you have screwed up the goal of achieving Rs 15 lacs in 5 years because you took an unnecessary risk.
 
You gambled because of your greed, ignorance or whatever. You risked something important for something that was not.
 
Buffett once used the example of Long Term Capital Management (LTCM) to explain about taking unnecessary risks. This is what he had to say (emphasis mine):

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“…If you take the 16 of them (LTCM’s people), they probably have the highest average IQ of any 16 people working together in one business in the country, including Microsoft or whoever you want to name – so incredible is the amount of intellect in that room.
 
Now if you combine that with the fact that those 16 have had extensive experience in the field in which they operate. I mean, this is not a bunch of guys who made their money selling men’s clothing and all of the sudden went to the security business or anything. They had, in aggregate, probably 350 or 400 years of experience doing exactly what they were doing.
 
And then you throw in the third factor: that most of them had virtually all of their very substantial net worth in the business.
 
They have their own money tied up, hundreds of hundred of millions of dollars of their own money tied up, a super high intellect, they were working in a field they knew, and they went broke.
 
And that to me is absolutely fascinating.
 
If I write a book, it’s going to be called “Why do smart people do dumb things?
 
To make the money they didn’t have and they didn’t need, they risked what they did have and did need – that’s foolish, that’s just plain foolish.
 
If you risk something that is important to you for something that is unimportant to you, it just does not make any sense.
 
I don’t care whether the odds are 100 to 1 that you succeed, or 1000 to 1 that you succeed.
 
If you hand me a gun with a thousand chambers or a million chambers, and there is a bullet in one chamber and you said ‘put it to your temple and pull it’, I’m not going to pull it. You can name any sum you want.
 
It doesn’t do anything for me on the upside, and I think the downsize is fairly clear.
 
I’m not interested in that kind of a game, and yet people do it financially without thinking about it very much.
 
It’s like Henry Kauffman said the other day – the people going broke in these situations are just two types: the ones who know nothing, and the ones who know everything.”

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Coming back to the example of funding your child’s education, you can easily blame bad luck for getting screwed up.
 
But is it really bad luck? I don’t think so.
 
Its rather a case of what this quote by DW Jerrold says:
 
Some people are so fond of bad luck that they run halfway to meet it. 🙂
 

So what is it that takes to save your money from yourself?
 
There is no set formula to not lose money. Also being smart is a good thing. But don’t be oversmart when it comes to money matters. Don’t do stupid things because you are greedy or impatient.
 
There are things you don’t know and more importantly, there are things that you don’t know that you don’t know! That is where the biggest risks lie. Make buffers for such unknown-unknowns. Also make buffers for known-unknowns like death.
 
Be aware of the potential downsides of your decisions. The potential upside is totally irrelevant if the downside is bankruptcy or death (as in case of Buffett’s gun example).
 
And as David Houke of Alpha Architect says, there are certain bets, regardless of how asymmetric they may appear, that should be beyond consideration by a reasonable and prudent actor. The second thing that can protect you is an awareness of what the potential monetary upside actually means to you, in practical terms.
 
The second point is really important.

What is that you are after? Does taking the additional risk actually help you in any other way apart from adding some extra money to your wallet? What is the true effect of additional returns on you and your life circumstances? It’s a question worth asking.
 
So if till now, you have managed to lose money in most of your investments, may be its time to think critically about your thought process, your assumptions, your risk-taking habits and what your financial priorities are.
 
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You + Are Smart = Will Be Rich?

You Smart Will Be Rich



The equation (You + Smartness = Rich) appeals to common sense. Its natural to believe that smart people know things that help them get rich. Isn’t it? Even I believe that on an average, smart people will be far wealthier than no-so-smart ones.
But still, when it comes to investing in stocks or managing money in general, there doesn’t seem to be much correlation between being extremely smart and being extremely rich.
 
Why is it so?
Jason Zweig has something to tell us about this (source):
It’s remarkable how much you need to learn in order to discover how little you ever needed to know. Smarts are overrated; the world is awash with smart people. What’s in short supply is wise people.
Apply the basic principles of the wisdom you’ve acquired from your experience elsewhere to investing, and you will probably fare better than many “smarter” investors.
Be skeptical, think for yourself, ask for evidence and probe it for weakness, control your emotions, distrust the fashionable, remember to assess not just how much you will make if you are right but how much you will lose if you are wrong — steps like these are basic good judgment and simple wisdom.
Often, people who know a lot about investing become so taken with their own knowledge that they forget the power of a few obvious questions.
Talking about what is required to actually succeed in investing, he says:
 
To master investing, you don’t need more than a basic understanding of economics. What you need to understand is psychology and history, because human nature doesn’t change and financial history is an endlessly repeating chronicle of all the mistakes other people have made.
The single greatest asset any investor can have is self-control — not a higher IQ, not better computers, not the earliest glimpse at information, but self-control.
The journalist Carol Loomis tells the story of a dinner party at which a woman finds herself seated next to Charlie Munger and asks:

“Tell me, Mr. Munger, what’s your investing secret?”
“I’m rational,” growls Munger, and goes back to eating his salad. 🙂
But there’s more to it than that, I think. It isn’t that great investors are unemotional; they’re inversely emotional. They have an ability to sense when other people’s emotions are getting out of hand, and then they take the other side of that trade.
 
Like his principles that I published a few days ago, even these words by Zweig make a lot of sense. More so when I think about all the smart people (I know personally) and who make tons of dumb investing mistakes.
Investors often sabotage their results when they try to get fancy. And rest assured, I have done my MBA from a good college and I can vouch for the fact that you don’t need an MBA to manage your money well or to reach your financial goals.
 
People think that MBAs (from good colleges) are smart and can do anything. That’s bullshit. 🙂
Investing successfully and achieving your financial goals is not about being smart or having the highest IQ or being popular. Rather, common sense and becoming incrementally wise (on a daily-basis) will get you there.
Some people are too smart to be rich. They give a lot of importance to what they know. But unfortunately and due to their personality (or maybe arrogance), they chose to ignore what they don’t know.
 
And that is exactly what does them in. And as Charlie Munger says:
“If you think your IQ is 160 but it’s 150, you’re a disaster. It’s much better to have a 130 IQ and think it’s 120.”
We all know that we are simply supposed to buy low and sell high. But that doesn’t happen. The majority have trouble following that sequence and instead end up buying high and selling low. And then there are those who become wise and find the right questions to ask themselves – but only when it’s (almost) very late.
Why? Not because they have less IQ or are not intelligent. But because they let their emotions and biases take over. A wise one will listen to his emotions but will act as the rational section of the brain advises.
When I was writing this post, I got a call from my childhood friend. On being asked, I told him about what I was writing. Now this friend of mine (based in US) is a successful entrepreneur himself. Being a Y-Combinator alumni, he told me about something which Paul Graham (founder of Y-Combinator) wrote in 2009. Though it was in the context of successful startups, some of it made sense in this discussion of (You + Smartness = Rich)’s context as well. This is what Paul wrote:
We learned quickly that the most important predictor of success is determination. At first we thought it might be intelligence. Everyone likes to believe that’s what makes startups succeed. It makes a better story that a company won because its founders were so smart. The PR people and reporters who spread such stories probably believe them themselves. But while it certainly helps to be smart, it’s not the deciding factor. There are plenty of people as smart as Bill Gates who achieve nothing.
But that’s about investing (and startups) in particular.
What about money (and getting rich) in general? I came across an interesting Q&A on Quora where a responder said:
Getting rich requires dealing with other people. Smart people spent a lot of time beefing up their IQ and not their EQ.

In most cases of highly intelligent people who are not rich, they have applied their brains to analytic reasoning. That’s a skill that might help calculate the odds of winning, but will not tell you what the other person is thinking.

IQ won’t give you the social EQ to turn a competitive situation into a cooperative one.
Don’t play chess at a poker game.
 
I think the last line nails it. 😉
 

WTF… Wrist Watch On EMI??

Either I am getting old or there is something seriously wrong with the way our generation has decided to manage their finances. Just last night, I was taking a stroll with my wife in South Mumbai when I saw a board outside a shop –

Wrist watches on EMI
A Ticking (Financial) Bomb On Your Wrist

This shop was selling wrist watches of some good medium-to-high-end brands. And it provided the customer an option of purchasing these wrist watches on EMIs!!
Now I am not saying that this is wrong. But seriously, isn’t it simple common sense to use loans to buy assets rather than wrist watches??

I am sorry that this post is short and a little aggressive. But I could not stop myself from sharing my agony at seeing such a financial crime being committed by young people. I don’t say that one should not indulge in buying what one likes. But there are other ways of buying a watch. Instead of taking a loan and paying EMIs, one can delay the purchase a few months and save money in a Recurring Deposit(or even a simple savings account) and then buy the product. Its that simple.

And this wrist watch thing was not just one-off case. My wife told me that now-a-days, even lady’s handbags are available on EMIs!!!!


I have nothing more to say. Period.

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