Wednesday, 7 September 2016

Lessons from Charlie Munger-XVIII

Mar 14, 2013




In the previous article, we discussed how humans have a natural tendency to submissively follow authority and how in some cases it can have tragic consequences. Today, we shall discuss this psychological tendency in the context of stock markets and how investors can wean themselves off this thinking error.


Authority-Misinfluence tendency in stock markets

Uncertainty and risk have a big influence on how independently people take their decisions. The greater the risk and uncertainty, the greater is the tendency to seek guidance and conformation from an authority figure. This makes the stock market a place that is incurably afflicted by the authority-misinfluence tendency. 

Just spare a moment and ponder about how exactly you decide when to buy or sell a stock. Do you invest based on 'hot tips' shared by 'influential' friends? Do you avidly track the portfolio of successful investors/ fund managers and try to mimic them? Do you invest based on the advice given by stock experts who appear on television? Do you blindly follow the advice of your broker or any other advisor? 

If your answer is a 'yes' to any one of these, then here are some more questions. What makes you follow these experts? Do you ever question or challenge their opinions? Do you trust them simply because they are in a position of authority? Is it convenient for you to follow them blindly so that you can escape the blame in case things go wrong? 
If you honestly reflect over these questions you will see that your decisions are seldom your own. In fact, it is not just small investors who fall prey to the wrong influence of authority. Even experts do, a lot of times.

You will recall that just prior to the stock market crash of 2008 most analysts had given a thumbs-up to an unreasonably expensive big ticket IPO of a famous corporate house. The IPO was oversubscribed a whopping 73 times! And then, not very surprisingly, the stock tanked after listing. In fact, it's been over five years since the stock listed and it is still down nearly 68% from its listing day closing price. This is what happens when one indiscriminately gives in to follow-the-leader tendency.

Of course, we are by no means suggesting that you should switch yourself off from all external help. This would be a stupid thing to do. Listening to views and opinions from experts is quite valuable. But there is difference between listening to experts with discretion and blindly following them. It is important that you exercise your own independent judgment to the opinions of others. 


'Mr Market' is there to serve you, not to guide you 

In an abstract sense, 'Mr Market' (as referred to the stock market by value investing genius Benjamin Graham) is a representation of an authority figure. People pay excessive attention to where the markets are going. But you must remember that 'Mr Market' is a fickle leader and often deviates away from the rational path. 

The greatest investors in the world are those who do not give in to the moods of 'Mr Market'. In fact, in his Letter to Shareholders in 1987, legendary investorWarren Buffett put down some very important lessons that he had learned from his Columbia Business School professor. Ben Graham had taught him to look at the market quotations as if they were coming from an emotionally troubled fellow called 'Mr Market'. The poor guy often goes through periods of euphoria followed by periods of gloom. But the good thing is that 'Mr Market' does not mind if you ignore him. His only job is to come up with a new quote every day, every few seconds.

So if you learn to command this peculiar gentleman, you can take advantage when he is gloomy and rack up great businesses at depressed prices. On the other hand, when 'Mr Market' is euphoric, you can simply ignore him. The most important thing to remember is to let the 'Mr Market' serve you, not to influence your investing decisions. 



https://www.equitymaster.com/detail.asp?date=03/14/2013&story=5&title=Lessons-from-Charlie-Munger-XVIII

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