Do You know the Secrets of Investment?
1. Cognitive Bias
In the world of investment, what are the cognitive biases that people usually make? For example：
A: How much did you lose? B: I earned 8,000 CYN in a project.
A: So how much did you lose? B: I bought it for 18 CYN and sold it at 30 CYN, so that I earned several thousand CYN.
A: And how much did you lose? B: In general, many of the projects I have invested have not been profitable yet.
A: Could you please tell me how much did you lose? B: I am currently losing tens of thousands of CYN, but I think it will definitely come back.
From the above dialogue, did you hear the deviations of several psychological and behavioral mistakes he made? First of all, he must be overconfident, and traded frequently which leads to losses. Secondly, he certainly has a stored value effect. When he earns a little bit of money, he immediately throws it away. But he still kept the currencies which have fallen on price, and wait for the day that it will rise back.
2. Mental Accounting
There has another bias called a mental accounting. This concept is simple and often heard in commercial marketing. When we organize and run our own lives, we will create different accounts for ourselves like accounting to weigh the pros and cons to calculate losses. A simple example can explain this concept.
If there are two fans now, they are going to see a game. One person’s ticket is bought and the other person got the ticket by his friend. On the day of the match, the weather forecast said that there would be a snowstorm this evening. Then the two fans, who are more likely to go to the snowstorm to watch the game. The answer is very simple, most people will answer that it must be the fan who pay for the ticket. Throughout the process, we will unconsciously set up a separate mental accounting for this role. So missing the game is equivalent to closing the account in the event of a loss in the account. For those who buy tickets, its losses are even more powerful, so in order to make up for this loss, he will be more inclined to temporarily not close the account, but risk the snowstorm to watch the game.
In the same way, we will also set up such a metal accounting for ourselves in the investment and separate our investment. Let me give you an example here. Suppose you need a sum of money to pay for the renovation of a house. So you have to sell some of the currencies, but now the market is in a bear market. When you open your own account, you will find that you have lost a lot. However, there still have one or two currencies are making money. You have been struggling for a long time and finally chose to sell these few currencies. On one hand, when you sell these currencies, you can feel a sense of success, because you earned money in the end. And those currencies have fallen, you will choose to delay closing the account, because you believe they will rise back one day. And this can make you feel better.
3. Language Expression
You will find that many psychological or behavioral errors are caused by language expressions. Let me give you another example. In the first case, a large-scale epidemic broke out in a country and affected 60,000 people. And there is a treatment plan that can cure 40,000 people. In the second case, a large-scale epidemic broke out in a certain country and 60,000 people were affected. And there is a treatment plan, but still have 20,000 people of this disease that cannot be solved.
In fact, you will understand that the two programs are the same, but in a very short period of time, people will choose the one that cures 40,000 people. In our investment, we often make such mistakes, always choose the investment which language expression sounds better. After all, these biases belongs to a psychological feature, which is a key word we are going to talk about today, called the narrow framework in the framing effect.
4. Framing Effects
1）Narrow Framework
Language builds a framework in our minds, and it is easy for us to think and make decisions under this framework. Most of times, we will set our own framework within a very narrow range which called a narrow framework. The mental accounting stored value effect and overconfidence just mentioned are all examples of thinking and decision making in a narrow framework.
2）Wide Framework
We just talked about the narrow framework. And is there a wide framework? There is such a statement in academics.
Let me tell you a very interesting thing. There is a movie called Star Trek. There are two people in Star Trek. One is Dr. McCoy from the earth, he is particularly impulsive every day, always lost control of his own emotions. The other one is the alien Spock. He is very logical, rational and very calm to think about problems and make decisions. In fact, these two kind of people also live in our brains, we call it A and B. The impulsive one is called A, the rational one is called B. The impulsive A system is a straightforward thinking system that disassembles complex things and makes a quick decision on a narrow framework. And the rational B system is an inferred complex logical thinking system. It will analyze, drill, and calculate everything. This is a very rigorous decision to make a decision on a wide framework.
But in our human evolution, the A system is the default system in our brain. Because it is simpler, more efficient, more convenient, and easier to help us make decisions. This is why we tend to make narrow framework to make decisions in our lives. This is the instinct of our biology.
5. Activate the Principle of Wide Framework Thinking
Benjamin Graham, the earliest value investor in history, said that the biggest enemy of investors is himself. What he means is that we have to make decisions in a wide framework and stimulate the B system in our minds. So what kind of thinking can we use to effectively activate this more cautious B system? I think there are two principles. The first one is diversified thinking and the second one is slow thinking.
1）Diversified Thinking
The so-called diversified thinking is to broaden the knowledge. Like Charlie Munger, when he invested in Coca-Cola, besides understanding the basic business factors of commercial profit, cash flow, competitors, etc., he also studied the nerve stimulation of this beverage from a biological point of view. He also considered the mysticism of human beings from a philosophical point of view. From the perspective of psychology, he considered the representative works of the hometown and the brand’s viscosity to the user. In this way, a diversified thinking model will naturally break your narrow framework. Those who lack relevant knowledge often fall into this narrow framework and are unable to extricate themselves.
2）Slow Thinking
Slow thinking is to suppress your own impulse to make decisions. When the price of the currency rose, do not think that the prosperity has arrived, the bull market has arrived. When the price of the currency fell, do not feel that the world is in chaos. Read more books, and think slowly under the framework of diversified thinking. This is a trick for us to restrain our inner demons.
6. Conclusion
My personal investment methods and insights have three main points.
First, the investment result of ordinary investors is not a win but a loss. The less you lose, the more you win.
Second, in order to reduce the number of losses, we should adopt a defensive strategy. Predict the intrinsic value of the project accurately, and then choose a safer margin of safety by comparing the price and the amplitude of the price.
Third, there is an important rule for those investors who don’t estimate business value, that is to avoid those hot projects and hot topics. Because when a project is hot enough, its price has been risen highly, so the possibility of breaking through the margin of safety will become higher and higher.
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