Friday, February 20, 2009

Investing and Over-Confidence

A couple of months ago, while traveling on business, I got together with a member of my extended family, a guy in his 20's who is in the process of learning to become an investment advisor. We spent about an hour together, during which all he could talk about was how he was going to make a killing trading stocks, bonds and commodities. What struck me was that this guy was very well versed in the language of professional investing while being completely oblivious to the true risks and opportunities of his chosen profession. 

He explained to me how investing was all about discipline, but his definition of discipline was slightly different from mine. My relative's investment strategy involves doing a lot of what he calls research, making a large number of bets, and always unraveling a position if it ever lost more than 5% of its value. I was somewhat amused and more than a little horrified that this level of knowledge and over-confidence was sufficient to make one an investment advisor. I asked my relative whether he has heard of the LTCM collapse. He said that he did. For those who are unfamiliar with the story, LTCM was a hedge fund that collapsed in 2000, in spite of having some of the world's most sophisticated investors (including an Economics Nobel Laureate) leading the organization. I asked my relative what made him confident that he could avoid financial calamity when much more experienced investors evidently could not, and he responded that discipline was the answer: never holding a losing position.

Yikes. This reminds me of teenagers when they first take the wheel of a car. They think they got it all under control until the smelly stuff hits the rapidly rotating blades of a wind making machine. Of course, we don't allow teenagers to teach others how to drive, but we do let teenager equivalents tell others where to invest their hard earned assets. Do you know anybody like that?

By the way, here's a hint: if you think you are on to an investment strategy that is going to make you a millionaire, and you are not already a Nobel laureate or have reasonable hopes of becoming one, you're probably wrong.

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4 comments:

Lise said...

The tiny amount of training that investment advisors receive is really mind-boggling.

I'm not sure what investment philosophy you subscribe to, but I'm reading The Intelligent Investor right now, which is supposed to be the classic text on value investing. I think the author would probably say that unless the underlying value of a commodity - not the trading price - dropped, you might consider getting out, but this would all be against the background of owning a company, rather than just a stock.

Millioniare Maker said...

I am reading the intelligent investor best now,which is related the classic opportunities.

Joel said...

He will do great. Investment advisers make money from selling their services to the public. Overconfidence and a "can't loose" attitude will always have a market.

Dana said...

People are still confusing investing and speculating, it kills me when the two terms are used almost interchangeably in everyday conversation. The over-reliance on mathematical models do not help either, but few have learned from the LTCM fallout.

The Wired has an interesting article out that discusses one such case. http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=all