The Intelligent Investor is likely to need considerable willpower to keep from following the crowd - Benjamin Graham

Have the Discipline to Say No

Arming yourself with a sound investment philosophy and search strategy puts you on the path to selecting businesses suitable for investment.  Once a business is valued, the most difficult determinants of whether to invest or not come into play.

Unlike valuation, which primarily relies on quantitative measures, investors now must rely on qualitative factors:

• Having the discipline to say no.
• Being patient.
• Having the courage to make a significant investment at a maximum point of pessimism.

These factors are exceedingly important because the probability of suffering investment loss is significantly higher due to the emotional underpinnings of these factors.

Most investors are smart; few, however, are disciplined enough to say no and move on or, more important, be patient.  Very few activities in life can be practiced successfully without some degree of discipline.  Being disciplined requires you to think independently and ignore crowd psychology.  Discipline requires investors to be confident in their research and analysis and be prepared to receive criticism from all angles.

Yet disciplined investors clearly realize that investment success comes from sticking to their methods and not participating in crowd folly.

Different styles of framing choices causes different preferred outcomes.

Loss Aversion, Risk, & Framing

The next stop in the framing inquiry involves the unique relationship of risk taking to positive and negative framing. Since losses loom larger than gains, it appears that humans follow conservative strategies when presented with a positively-framed dilemma, and risky strategies when presented with negatively-framed ones. To illustrate, consider Kahneman & Tversky's 1984 study where they asked a representative sample of physicians the following question. Read and answer it before you continue.

Imagine that the U.S. is preparing for the outbreak of an unusual Asian disease, which is expected to kill 600 people. Two alternative programs to combat the disease have been proposed. Assume that the exact scientific estimates of the consequences of the programs are as follows: If program A is adopted, 200 people will be saved. If program B is adopted, there is a one-third probability that 600 people will be saved and a two-thirds probability that no people will be saved. Which of the two programs would you favor? 

Be sure to answer this question before you proceed.

Have you answered? OK.

Notice that the preceding dilemma is positively framed. It views the dilemma in terms of "lives saved." When the question was framed in this manner, 72% of physicians chose A, the safe-and-sure strategy, but only 28% chose program B, the risky strategy. An equivalent set of physicians considered the same dilemma, but with the question framed negatively:

Imagine that the U.S. is preparing for the outbreak of an unusual Asian disease, which is expected to kill 600 people. Two alternative programs to combat the disease have been proposed. Assume that the exact scientific estimates of the consequences of the programs are as follows: If program C is adopted, 400 people will die. If program D is adopted, there is a one-third probability that nobody will die and a two-thirds probability that 600 people will die. Which of the two programs would you favor? 

You can see that the two questions examine an identical dilemma. Two hundred of 600 people saved is the same as 400 of 600 lost. However, when the question was framed negatively, and physicians were concentrating on losses rather than gains, they voted in a dramatically different fashion. When framed negatively, 22% of the physicians voted for the conservative strategy and 72% of them opted for the risky strategy!

As you can see, framing the choice positively vs. negatively caused an almost perfect reversal in the choices of highly-trained experts making a decision in their field of expertise--saving (or is that 'not losing'?) lives! Clearly, framing can powerfully influence the way a problem is perceived, which in turn can lead to the favoring of radically different solutions.

Let's consider the same "negative frame => risky behavior" phenomenon from a somewhat less theoretical and more practical perspective. Imagine that you are a medical practitioner, and you have just seen your third case of advanced breast cancer in a single week. "Why," you wonder to yourself, "aren't these women performing breast self-exams (BSEs) and finding these lumps before they become full-fledged, life-endangering metastatic cancers?" Your clinic hands a brochure on BSE to every woman that enters the door, BSE is regularly described in newspapers and on TV; information on this topic isn't exactly scarce! Why do your patients choose to die rather than comply? you wonder.

But consider the act of a BSE. Logically, it's safe--but psychologically, it's a risky procedure. If you perform BSE, you may feel a lump. So performing BSE is a risky behavior, because by looking, you may find something you don't want to find. Not performing a BSE is a logical health risk behavior, but is safer psychologically. By not looking, you won't find anything that may cause you to worry.

Researchers Meyerowitz and Chaiken explored this very question in a 1987 research project. They distributed one of two brochures on BSE to equivalent patients in equivalent clinics. The brochures were identical in terms of content, but one stressed the gains associated with performing a BSE, and the other focused on the losses associated with inaction. You can guess the result, can't you? The negatively-framed brochure lead to higher positive BSE-related attitudes and behaviors. Actually, the true strength of the negative frame emerged four months after patients received the brochures. Those who received negatively-framed brochures showed significantly greater intentions to perform BSE at the later date.

Why is it that negative information causes increased persuasion in these types of situations? Psychologists have long known of the existence of the "positivity bias," which states that humans overwhelmingly expect good things (as opposed to neutral or bad things) to occur. If perceivers construct a world in which primarily positive elements are expected, then negative information becomes perceptually salient as a jolting disconfirmation of those expectations (Kanouse & Hanson, 1972). We also know that people stop to examine disconfirmations to a much higher degree than confirmations. Negative information is often highly informative and thus may be assigned extra weight in the decision-making process (Fiske, 1980; Smith & Petty, 1996). Let me ask you: if you learned that your friend's auto mechanic performed an excellent valve job but botched his automatic transmission repair, would you take your car to that mechanic? No, because negative information overwhelms positive information. You expect a mechanic to be effective, period.

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This topic is considered in further detail for the benefit of my students, who must enter the URLs found on the syllabus to access the following pages (if you're not a student of mine, please don't ask! The answer will be "Sorry."):

• Positive & Negative Frames (They're both effective in the appropriate circumstances, but you need to know which is best to use when.)
• Why Experts Fail to Predict (One reason experts make stupid mistakes.)
• Framing by Position (The real reason for the cheap and expensive models in the product lineup.)
• Framing by Contrast (How contrast is used to make you do things you wouldn't otherwise do.)
• Framing by Attribution (One of the most seductive persuasion tactics around because it makes people feel good!)

Ref:

http://www.workingpsychology.com/lossaver.html

http://www.workingpsychology.com/mediafr.html
Media framing (How the media frames the news and shapes public opinion.)

Luck versus Investing. Luck plays a part in every investor's life.

Value investing certainly requires a bit of luck, but it is mostly based on perseverance and discipline.  Since you will be taking some risk as you pick beaten-down companies, you do need the luck that most of these risks will pay off.  You also need the discipline to stick with your choice, knowing it will eventually pay off even if things don't look good immediately.  And, yes, some of those risks won't pay off.

Luck plays a part in every investor's life, but few credit their success to being lucky.  So don't count on luck to get you where you want to go.

Discipline is the key to the door of success for value investors.  You have to know how to set your investing goals and stick to them.  You must have the ability to develop your own road map to success without having to worry about taking directions from others.   You also need to become an accumulator of wealth and have the discipline to not spend as much as you make, so you have money to invest when you find a good bargain.




Remember, disciplined people are not easily side-tracked.  They:

• set their sights on a series of lofty goals,
• figure out strategies for meeting those goals, and 
• have the discipline to not lose sight of those goals, even if they stumble and fall along the way.  

They get up, fix the problems, and continue to stay focused on their ultimate goals.

Develop the Value Investing Mind-Set

Value investors must think long term and not think that making a quick profit is their first priority.  You must realize that you won't be investing in the same types of stocks as your friends, and you won't be able to compare quarter-to-quarter returns.

You'll also need to enjoy digging into the annual reports of the companies that interest you and be prepared to analyze everything you see.  Successful value investors are those who enjoy researching and learning everything about a company before diving in and investing.

The key tools you'll need as a value investor are:

• Patience to wait for the market to realize you found a gold mind in a beaten-down stock.
• Discipline to spend the time researching your choices and not get caught up in the mob mentality as people push stocks higher and higher above their true value.
• Desire to learn all you can about choosing the right industries to explore, picking the right stocks within those industries that are unjustifiably beaten down, and then having the courage to wait until the market realizes what a great investment it is missing.
• Ability to check your emotions at the door.  Don't get emotionally involved in your stocks.  Your value portfolio is way to make money.  Don't fall in love with it or the stocks in it.
• Expectation of adequate profits but not extraordinary performance.  Historically the average annual return for stocks in any 20-year period is about 10 to 12 percent per year.  That doesn't mean you'll earn that amount each year:  some years will be higher, some lower, but that's the average return you should expect with a long-term stock portfolio.
• Ability to calculate what a stock is worth, based on careful analysis of the business.  Don't gamble on how much the stock may go up because someone else is foolish enough to pay that.  Eventually, the fools disappear and you could be left holding the bag.
• Ability to think for yourself.  Unless you've found a friend who is also dedicated to the idea of becoming a value investor, don't count on those around you for support.  You must learn to think for yourself.

In the preface to Benjamin Graham's The Intelligent Investor, Warren Buffet writes,  "To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information.  What's needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework."

Investing: Discipline, First and Foremost

Investing: Discipline, First and Foremost

"The essence of mathematics is not to make simple things complicated, but to make complicated things simple."

If you want to beat the market, you need to pick a strategy and stick with it - NO MATTER WHAT. In What Works on Wall Street, O'Shaughnessy writes that in order to beat the market, it is crucial that you stay disciplined. "Consistently, patiently, and slavishly stick with a strategy, even when it's performing poorly relative to other methods."

O'Shaughnessy believed that emotions were perhaps the greatest enemy of the investor because feelings like fear, anxiety, and excitement can cause an investor to ditch his long-term plan for hot strategies or hot stocks that turn out to be financial mirages. "We are a bundle of inconsistencies," he continues, "and while that may make us interesting, it plays havoc with our ability to invest our money successfully.... Disciplined implementation of active strategies is the key to performance."

A decade later, his thoughts about sticking with strategies haven't changed. "What always work on Wall Street is strict adherence to underlying strategies that have proven themselves under a variety of market environments."

A crisis mentality among investors

Professionals, even the most seasoned, have the same emotions as everyone else. Learning the ropes professionally does not eliminate human emotion, nor does it elimate urges to buy or sell emotionally. Faced with uncertainties, the tide of emotion surges. How can one resist the surging tide of emotion? Only if one has a framework of disciplines and knowledge within. Controlling emotions and replacing them with the elements of this framework are the secret.