How Understanding Behavioural Finance Helps In Value Investing

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In an interesting independent TED talk at Brigham Young and Emory Universities, psychologist Dr. Daniel Crosby explains how his study of behavioural economics and finance shows that “being weird” and embracing it can actually make one rich.

By being weird, he actually meant being different from the majority of the market players and stock traders. In this sense, Dr. Crosby’s idea is actually quite applicable to investing and specifically, the practice of value investing.

We’ll take a closer look at Dr. Crosby’s idea and how understanding it can actually help us get a deeper understanding of value investing, well beyond “buying excellent companies run by great leaders at undervalued prices and holding for the long-term”.

He mentioned three main instances — or reasons — to be “weird” in things his audience could do, especially in finance and investing: principled defiance, intelligent risk, and hidden value.

Principled defiance

The key idea about principled defiance is to go against the mainstream, the norms or the majority, but not without a certain set of principles. In other words, oppose the world if you think that help you succeed or make a huge profit, as long as you have a very good reason for it.

Isn’t this quite similar to what the Oracle of Omaha advocates? “Be fearful when others are greedy and greedy only when others are fearful.” Of course, one cannot just be contrarian — doing the exact opposite of the mainstream — for the sake of it, especially in investing.

Due diligence and detailed research should still be done. Because the surprising thing is, markets are hardly rational. Most activity in the stock markets might actually be the result of senseless reactions to news and motivated by emotions, which brings us to the next point.

Intelligent risk

In any decision in life, be it in the stock markets or in the business sphere, there are always risks — losing capital, losing time, losing relationships, etc. No one likes to take risks, especially when things that are important to us, such as money, time and close relationships could potentially be lost.

But we do know that returns and risks are quite relative — high risk, high returns, right? But because markets are hardly rational, investors like Warren Buffett are able to get rich from value investing. So in the case of stock markets, high returns might not necessarily come with high risk, but rather, intelligent risk.

Dr. Crosby said it pays to take a little intelligent risk to live one’s life better. In stock investing, if one does one’s due diligence and homework to single out “excellent companies run by great leaders selling at undervalued prices”, the risk to buy those stocks when everyone is rushing for the exits, might actually be pretty smart.

Hidden value

The last idea Dr. Crosby shared was to find the value in things that others consider “trash”. This is very much like the value investing in the stock markets. It is the stocks of companies that people think lowly of that actually have some sort of “hidden value”.

Value investors are the ones who are able to look at these companies objectively and say, forget about all the short-term problems these companies are facing and evaluate if they can survive over the long-term.

It is precisely these companies that are able to give value investors who see the value in the companies’ long-term business performance, not just the stock performance. After all, the stock price of a company seldom reflects the value and potential of the company, it is more of an indication of market sentiment.

Apply these to value investing

Value investing requires a lot of patience and discipline. The next time someone questions your value investing principles, let them know about these behavioural finance concepts put forth by Dr. Crosby.

These can better explain the deeper ideas about value investing and could be more appealing to critics of (ironically) one of the most successful investing strategies of all time.

*Key points in this article were taken from an independent TED talk by a psychologist Dr. Daniel Crosby.

This article was originally posted on Aspire. Aspire seeks to provide thought leadership content, insights and advice for individuals who aspire to be a better version of themselves.

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