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Biases That Cause You To Make Mistakes

  
  Education
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You are your own worst enemy.

Those are the six most important words in investing. Shady financial advisors and incompetent CEOs don’t harm your returns a fraction of the amount your own behavior does.

Here are 15 cognitive biases that cause people to do dumb things with their money.

1. Normalcy bias
Assuming that because something has never happened before, it won’t (or can’t) happen in the future. Everything that has ever happened in history was “unprecedented” at one time. The Great Depression. The crash of 1987. Enron. Wall Street bailouts. All of these events had never happened… until they did. When Warren Buffett announced he was looking for candidates to replace him at Berkshire Hathaway, he said he needed “someone genetically programmed to recognize and avoid serious risks, including those never before encountered.“ Someone who understands normalcy bias, in other words.

2. Dunning-Kruger effect
Being so bad at a task that you lack the capacity to realize how bad you are. Markus Glaser and Martin Weber of the University of Mannheim showed that investors who earn the lowest returns are the worst at judging their own returns. They had literally no idea how bad they were. “The correlation between self-ratings and actual performance is not distinguishable from zero” they wrote.

3. Attentional bias
Falsely thinking two events are correlated when they are random, but you just happen to be paying more attention to them. After stocks plunged 4% in November 1991, Investor’s Business Daily blamed a failed biotech bill in the House of Representatives, while The Financial Times blamed geopolitical tension in Russia. The “cause” of the crash was whatever the editor happened to be paying attention to that day.

4. Bandwagon effect
Believing something is true only because other people think it is. Whether politicians or stocks, people like being associated with things that are winning, so winners build momentum not because they deserve it, but because they’re winning. This is the foundation of all asset bubbles. (more…)

Why Do More People Just Not Say: Hypocrite

  
Analysis, Education
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From Bloomberg Nov 4, 2011:

Warren Buffett’s Berkshire Hathaway Inc. (BRK/A) said third-quarter profit fell 24 percent as derivative bets declined in value.

From BBC March 4, 2003:

Mr. Buffett argues that such highly complex financial instruments [derivatives] are time bombs and “financial weapons of mass destruction” that could harm not only their buyers and sellers, but the whole economic system. Some derivatives contracts, Mr. Buffett says, appear to have been devised by “madmen”. In his letter Mr. Buffett compares the derivatives business to “hell…easy to enter and almost impossible to exit”…

He might be rich, but let’s face it: he is one manipulative character.

Warren Buffett – The World's Greatest Money Maker-Video

  
Education, Video
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If you invest in the stock market you’re almost 100% certain to have heard of Warren Buffett. Indeed, you’ve probably read books about him, or you might have read his annual shareholder letter, or even been to the spectacle that is the Berkshire Hathaway annual shareholders meeting.

Now’s your chance to watch an interesting documentary that offers an intimate look at the life of Warren Buffett. The documentary offers an eye opening view of how he runs the company (complete with a tour of his office), the annual shareholders meeting of Berkshire Hathaway, and a peak at his many eccentricities.

Of course the film also reviews how he made his money, how he operates, how he came to operate in the way he does, and how he thinks about his wealth which is in the tens of billions of dollars.

Buffett on Stock Prices

  
  Education
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Its early in this potential correction, but let me remind you of Buffett’s interesting (1997) comments:

“If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef?

Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices?

These questions, of course, answer themselves. But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period?

Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.”

–Warren Buffett, chairman’s letter, Berkshire Hathaway annual report, 1997 

 
Its worth thinking about, regardless of whether the recent investor nervousness turns into something more significant . . .

Warren Buffett's Worst Trade & Biggest Mistake

  
Analysis, Education
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Investors always remember their worst trade or biggest mistake. Warren Buffett is no different. However, Buffett’s biggest mistake might surprise you. In an interview with CNBC, the Oracle of Omaha admitted that the worst trade of his career was buying Berkshire Hathaway (BRK.A). Imagine that. But if you dig deeper into his account of the story, you’ll see that while his worst trade might have been buying Berkshire Hathaway, his biggest mistake was letting emotion get the better of him.

Embedded below is the video where Buffett talks about his worst trade in Berkshire Hathaway

ARE YOU A SPECULATOR?

  
  Education
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Consider this excerpt:

Benjamin Graham, who believed in buying wonderful companies at a fair price rather than a fair company at a wonderful price, defines an investor as “an individual whose investment provides two quantitative qualities – safety of principal and an adequate rate of return.” There are many intricacies within business ownership investments, but does everyone in the stock market consider these particulars when investing in business ownership? Of course not, because not everybody in the stock market is an investor. Individuals who desire to become investors must enter the arena with goals that have a long-term investment horizon. Warren Buffett, a global financial market guru and head of Berkshire-Hathaway, puts it best when he says: “It’s bad to go to bed at night thinking about the price of a stock. We think about the value of a company and the company results; the stock market is there to serve you, not instruct you.”Hence, an investor does not buy a price and will not be affected by the ups and downs of the market. A sound investor buys well-managed businesses, with strong earnings growth and significant barriers to entry that will provide long-term security. A ‘purchaser of price’ is a speculator; a ‘purchaser of solid businesses’ with sound fundamentals is an investor.Mark Croskery

Warren Buffett Nails It On The Importance Of Luck In Life

  
Education, Life
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WARREN BUFFETT: Well I came up with that a long, long time ago to describe the situation that – I was lucky. I was born in the United States. The odds were 30 or 40-to-1 against that. I had some lucky genes. I was born at the right time. If I’d been born thousands of years ago I’d be some animal’s lunch because I can’t run very fast or climb trees. So there’s so much chance in how we enter the world. And –

LIU: And you were always aware to make sure your children and their grandchildren, and your grandchildren would be grounded.

WARREN BUFFETT: Yes. And we’re not – how you came out of the womb has really nothing to do with what kind of person you are. You decide what kind of person you’re going to be. It does decide whether maybe you never have to do an item of work in your life and maybe determine whether you’re fighting uphill all of the time, but where in my life, in my eyes is we’re all created equal, and but we don’t all have an equal opportunity by a longshot. And my kids really work every day in trying to even up the scorecard.

Luck plays a big role in life.  But you also get to choose how you’re going to use that luck and whether you want to try to make more of your own luck.

The Success Of Warren Buffett

  
  Education
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Singular focus – Since Warren Buffett was a young boy, he had almost a singular focus to accumulate wealth. He also believed his way to wealth would be through the stock market. At a very early age, he knew what he wanted and where he wanted to go. Successful people always have long-term visions of their life. This is a lesson especially for younger folks. You will only really succeed in life once you know what you want to accomplish. As Yogi Berra said, “If you don’t know where you are going, you may end up some place else.”

Dedication – Mr. Buffett spends about 18 hours every day dedicated to investing capital. This is the type of dedication needed to succeed at his level. I doubt he wastes anytime in front of the television or shopping at the mall. Almost all his time is spent thinking and working on Berkshire Hathaway. This type of dedication can have its drawbacks as well. The book does not portray his family life in a very positive manner. He was separated from his first wife (it appears they did not divorce for P.R. reasons) and did not spend much time with his children as they grew up. There is only so much time in a day, and he spent it mostly on business-related activities.

Independent thinking – Buffett has come up with his criteria for investing in companies. These criteria have been developed over years of studying and reading about his craft. He will only invest in companies that meet these criteria. He does not feel pressured when things do not go his way nor when outside sources suggest new rules for investing. The most telling story of this was back in 1999 during the “technology stock bubble”. Many people were saying he was too old and out of touch. They said he did not understand the “new economy”. Buffett continued to plot his course using the rules he knew and understood. He has been vindicated as the technology market crashed and Berkshire Hathaway has continued to thrive.

Alliances – Mr. Buffett has developed partners and allies to help him attain his goals. He uses these partners to manage his businesses, help find new investments, and to obtain access to capital. Mr. Buffett will be the first to tell you that his wealth would be a small fraction of what it is today without these business associates. (more…)

30 Quotes For Traders/Investors

  
  Education
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“Wall Street people learn nothing and forget everything.”  Ben Grahameyes-MIRC

“ Buy on the cannons, sell on the trumpets.” Old French Proverb

“A stock broker is one who invests other people’s money until its all gone.”  Woody Allen

“It is fortunate for Wall Street as an institution that a small minority of people can trade successfully and that many others think they can.” Ben Graham (more…)

Warren Buffett: Markets are like sex

  
  Education
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There’s nothing like getting a big bang for your buck, and no one knows that more than billionaire investor Warren Buffett.

The 83-year-old founder of Berkshire Hathaway, whose investments have consistently beaten the stock market over the past 50 years, shared a few tips in this year’s annual letter to shareholders, including comparing the stock market with sex.
Mr Buffett said new investors tend to buy shares when the markets are rising and optimism is high, only to get disillusioned when prices fall.
Quoting the late money manager Barton Biggs, whose attention to emerging markets in the 1980s marked him as one of the world’s first and foremost global investment strategists, Mr Buffett added: “A bull market is like sex. It feels best just before it ends.”

He advised investors to “keep things simple” by “accumulating shares over a long period, and never sell when the news is bad and stocks are well off their highs”.

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