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  • How not to invest

    Five instincts you’ll want to act on, but shouldn’t.

    Your investing don't do list

    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

    Kane Tanaka is the oldest person still alive. She’s 117, and was born in the same year the Wright Brothers achieved powered flight. It feels right to say, at her age, "She’s seen it all".

    But, with great respect, she hasn’t.

    She’s lived through 0.06% of human history and less than 0.000003% of our planet’s past.

    A huge amount has happened since Kane was born, but an order of magnitude more went unseen before she arrived, prematurely, on 2 January 1903.

    Based on how we live, it’s hard to believe that for 99.9% of our species’ time on Earth, survival has been our only priority. Then again, if Everest symbolised human evolution, today’s population would be taken care of by some snowflakes on the summit.

    This is the context we should approach investing with.

    We weren’t designed to invest, investing just happens to be the next rung on our evolutionary ladder. Our instincts, drive and emotions were formed hundreds of thousands of years ago for the sole purpose of keeping us alive.

    Applying these primal thought patterns to financial markets is like bending wrought iron. You’ll get nowhere unless you apply some heat.

    When it comes to investing, your heat source isn’t what you know, but how you behave. Your biases and instincts are pre-programmed and so well polished, you rarely even notice them. But if you don’t try to control them, your portfolio will never bend to your will.

    Which means the power is in your hands. The one thing that will make the biggest difference to your future wealth – your behaviour – is the only thing in your control. No GDP, employment or poll number you’re scared about will come close.

    And there’s more good news. Most of what you read urges you to do something – buy this, sell that. But in the real world, it’s often what you don’t do that’s more helpful. As Charlie Munger, Warren Buffett’s right-hand man, said:

    "It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent."

    So here’s a list of five instincts you’ll want to act on, but shouldn’t, as you aim to grow your money in the market.

    This article isn’t personal advice. If you’re not sure of the right course of action, take advice. All investments rise and fall in value, so you could get back less than you invest.


    1

    Don't just do something,
    sit there

    Humans tell stories. Whether in hieroglyphics on walls, ink on parchment or CGI on Netflix, stories are a constant feature in each generation’s tale. American author Kurt Vonnegut put it neatly;

    “Tiger got to hunt, bird got to fly; Man got to sit and wonder, ‘Why, why, why?’ Tiger got to sleep, bird got to land; Man got to tell himself he understand.”

    We thirst to understand the environment around us, and we do that by simplifying ideas into stories. From the shape of the world, to how apples fall off trees, and why chickens peck the ground the moment they hatch, we create a narrative explanation.

    The problem is, the world can’t be condensed so gracefully, it’s too complex - just think how many scientific theories have been proven wrong.

    Which is how we get in trouble with our investments. Every morning, there’s an avalanche of news, and our instincts tell us we should read, compute, and use it to take corrective action.

    And if the stories are gloomy, our instincts go into overdrive because, if someone shouts, “You’re under attack!” it’s wise to run first and question second.

    But as Charlie Munger says, “Invert, always invert”. Or in more words; if it feels right, do the opposite. Which is sensible for a few reasons.

    • "If it bleeds, it leads" – bad news sells, so you’re likely to read about bad case scenarios, even if they have a low probability of happening. Think about the author’s incentives; they want to sell papers, or attract eyeballs. Growing your retirement pot may not be high on their list of objectives.
    • Over the long course of history, optimism has triumphed. The world has improved and with it, stock markets have risen. There will be setbacks, they might be significant, just as there have been in the past, but a negative view is an implicit bet against humans’ ability to adapt, survive and flourish. The weight of 200,000 years of evolution begs you not to take that bet.
    • Outside of financial markets, running from supposed trouble doesn’t cost much. Inside the ropes, the costs can be crippling. It might cost you to trade in the first instance, but if you sell and the market rises, you’re stuck with another issue; when do you get back in? Our experience says investors don’t and instead remain on the side-lines regretting gains they would’ve had.

    Charlie Munger again: “The first rule of compounding: Never interrupt it unnecessarily.” You'll need to review your investments regularly but if you’ve got a diversified portfolio and a sensible long-term plan, stick with it. If you don’t, spend time working on these foundations, rather than worrying about how it might all end.


    2

    You can't win if you
    don't lose

    Babies born today have won the generational lottery because the world’s never offered so much hope.

    200 years ago, a baby born in Europe was expected to live until 33. Today, they can look forward to life in their 80s.

    But, as you flick through the annals of the most innovative 200 years the world’s ever seen, you find atrocity after atrocity. To name a handful; the Napoleonic War, American Civil War, Crimean War, Cholera Epidemic, San Francisco earthquake, World War I, Spanish Flu, Great Depression, World War II, Cold War, Vietnam War and Persian Gulf War.

    Yet, in spite of unimaginable suffering civilisation has progressed at an unprecedented rate. Economic output per person has increased by 1000% on average, and electricity, telephones, cars, computers, clean water, penicillin, airplanes and so much more have become part of our language and lives.

    Counterintuitive as it may be, destruction and innovation go hand-in-hand. The Big Bang theory should have taught us that, but regardless of when we learn it, the concept is both real and important - particularly for investors.

    The market is something that gets better over time, but when you pull back the curtain, all you see is chaos, loss and destruction.

    Take the US stock market. From 1925 to 2015, it turned $100 into $31,134 even after inflation. But if you surveyed investors during any part of that period, they’d never say it felt as good as it sounds.

    Because when you look at how that return was generated, 58% of stocks did worse than money on deposit and only 4% of stocks accounted for the market’s entire return.

    Naturally, you might say “Great, I’ll just buy and hold the 4% of winners.” But that’s not possible because those stocks are only knowable in hindsight. Here’s why.

    Amazon has grown more than 100,000% since it listed but along the way investors have seen it fall 95% once, over 50% six times, 15% one-hundred times and 6% in a day, nearly two-hundred times.

    Chances are, you gave up thinking Amazon was a winner the first time it halved your money.

    So remember, destruction and innovation are inseparable. The only way you can take advantage of winners is to accept losers. Once you’ve assessed your appetite and tolerance for risk, park your instincts, diversify properly and stick with it long-enough to let the winners take care of the losers.


    3

    Know what you don’t know

    JK Galbraith, a renowned economist, said:

    There are two kinds of forecasters: those who don't know, and those who don't know they don't know

    Don't be the second kind.

    Bill Gates also said we "overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten."

    To prove that, here’s a picture of what Microsoft’s nemesis, Apple, had on their homepage nearly twenty years ago, on 5 April 2001.

    Who remembers iTools and iCards? Neither do we but more pressingly, the company’s share price had fallen nearly 70% in twelve months. You could buy an Apple share for $1.47 at the time, which looks a bargain price today but didn’t seem such a great deal at the time.

    The company’s two-year future looked bleak, and no one predicted what would happen over the next ten years. Not even Apple.

    Back then, they made almost all their money from selling computers. In their annual report, Steve Jobs projected we’d enter "a new era in which the personal computer will function for both professionals and consumers as the digital hub for advanced new digital devices such as digital music players, personal digital assistants, digital still and movie cameras, CD and DVD players, and other electronic devices".

    His forecast came true, just not in the way he expected. Apple ripped up its business model to make a phone which did away with personal computers, music players, and cameras. Today, they make only 10% of their money from computers, and over 60% from phones.

    Apple’s lessons for investors are important.

    1. Building an investment plan around how you think the future will unfold is tough because even companies which shape the future don’t know how they’ll do it, beforehand.

      Winston Churchill put it this way: "It is a mistake to try to look too far ahead. The chain of destiny can only be grasped one link at a time."
    2. Secondly, embrace uncertainty because risk and return are linked. Buying Apple shares at $1.47 was painful, but it got worse because two years later they were $0.95. You don’t get great returns if you’re not willing to take on pain. And the more return you’re after, the more pain you’ll be subject to.

    Fashions are fickle.

    Until the 20th Century, prisoners, servants and pets used to eat lobster three or four times a week. It was nothing special, they were dubbed “cockroaches of the sea”, lay in two-foot high piles along the Northeast Coast of America and were sold in supermarkets for less than a can of baked beans.

    Then, as railways began to spread throughout the U.S., entrepreneurial train conductors realised they could buy lobsters cheaply and serve them to unsuspecting passengers, who didn’t live close to the coast, as if they were exotic and rare.

    Amazingly, passengers found them delicious and many began to ask for lobster once they disembarked. Chefs caught on, and by the late 1920s, prices peaked as supply began to dwindle.

    That is, until the great depression, when no-one could afford luxury lobsters anymore. Prices sunk, the mystique wore off, and they were given to American troops, holed up in French trenches during World War II, as a cheap source of protein.

    They’ve since made it back to celebrity status but their yo-yo ride of popularity teaches us a lot about the nature of stock markets and investors.

    If you’ve never seen a lobster, and I serve you one while describing it as a ‘cockroach’, chances are you won’t enjoy it. But, if I call it exotic and make it appealing, chances are you’ll find it delicious.

    Gestures, words and pictures prime us to act in a certain way, often without us knowing. A rising market or investment is a classic example. We take it as proof it’s destined to keep rising, the wisdom of crowds has anointed it so. And when markets begin to fall, the opposite applies.

    When it comes to money, the problem with using crowds as evidence of accuracy is that opportunity is almost always inversely related to popularity.

    Which is why the world’s most famous investor, Warren Buffett, tells people to "be fearful when others are greedy and greedy when others are fearful."

    But, like most things financial, it’s easier said than done. Just ask Sir Isaac Newton.

    Newton invested in the South Sea Company, which rose from £128 to £1050 in early 1720. But sensing the speculative nature of the move, he sold his £7000 worth of stock and commented that he could "calculate the motions of the heavenly bodies, but not the madness of the people"

    And he was right. By September that year, the bubble burst and the company’s shares fell 80% from their peak. However, in spite of what he said, Newton’s urges got the better of him. It turned out, as the shares continued to rise, he bought back in, and bought more than before. So when they the shares fell back to earth, he lost £20,000, or £2.3 million in today’s money.

    Investing isn’t about what you know, or how smart you are, it’s about how you control your instincts. As social creatures, we’re drawn to what’s popular, but in markets, popularity and profitability are the same poles of different magnets. They repel each other.


    5

    Don't overcomplicate it. Less
    becomes more

    When you look back at the history of some of today’s biggest companies, something unusual stands out.

    Garages.

    Amazon, Apple, Google, Virgin, Microsoft, Dell, HP and Disney all started in a garage and have gone on to become huge successes. So much so that a few of their products probably sit in your garage now.

    Could a modest first office hold the key to future success? Unlikely. But it goes to show that big things start small.

    We’re so used to seeing finished products that it’s easy to forget how they came to be. Success almost always comes from starting with something small, and repeating it over and over again, without stopping.

    Investing is no different. The key is to find a process that works for you, that allows you to ignore distractions, and that you can repeat over and over again. Because, that way, compounding comes into its own.

    But how do you do that? It’s simpler than you think, and I’ll let some four-year-olds explain why.

    In the late 1960s, a psychologist ran a simple experiment involving four-year-old children.

    He invited the kids into a tiny room with only a desk and a chair and asked them to pick a treat off a tray of marshmallows, cookies, and pretzel sticks.

    The four-year-olds were then made an offer: they could take one treat or, if they waited while he left the room, they could have two treats when he returned in a few minutes. Not surprisingly, nearly every kid chose to wait.

    At the time, it was thought the ability to delay instant happiness in order to get that second treat depended on willpower. Some people simply had more willpower than others, which allowed them to resist tempting sweets or save money for retirement.

    But, after watching hundreds of kids take part in this experiment, they realised that was wrong. Willpower was inherently weak and children who tried to postpone the treat soon lost the battle, often within thirty seconds.

    When they studied the small number of kids who successfully waited for the second treat, they found, without exception, they had used the same strategy.

    They did all they could to stop themselves from thinking about the treat.

    Some covered their eyes, others sang songs, a few repeatedly tied their shoelaces, and a couple pretended to nap. They didn’t defeat their desires, they just forgot about them.

    Too often, we assume willpower is about being mentally strong. But it’s actually about learning how to control that short list of thoughts in your head. It’s about realizing that if we’re thinking about our portfolios, we’re going to start tinkering, which might stop compounding.

    So create a robust plan, which diversifies your money, works towards your goals, and helps you sleep at night. Decide how often you'll review your plans. Then turn-off your phone, close your laptop and think about something else.

    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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