Like most investors, I spend my time reading financial statements, perusing market data, and staring at computer screens as I search for new ideas that benefit both my clients and readers of my weekly newsletter EPIC Insights. While such a routine has the benefit of allowing us to be more in tune with each subtle change that occurs, it also carries great risks. If we allow our world to be dominated by numbers flashing across the screen, it is easy to lose perspective.
I always attempt to find balance in my market-focused day. One approach that influences my writing is to study non-market events and attempt to derive a message from them. By looking outside of the market, I can think creatively as I develop strategies that benefit my clients.
This week, my out-of-the-box thinking has brought me to the Titanic. Lovers of history or Leonardo DiCaprio are familiar with the story. A seemingly unsinkable ship strikes an iceberg and sinks, and a tremendous loss of life ensues. So how does the Titanic apply to investing? The disaster of the Titanic was the result of three powerful behavioral traits-hubris, recklessness, and impulsivity. These same traits can have disastrous effects on your wealth.
Firstly, hubris refers to arrogance that clouds ones judgment and leads to their ruin. Those who built the Titanic felt it was unsinkable and that typical safety precautions were unnecessary. When disaster struck, the ship was not prepared to handle a mass evacuation.
Investors often fall into a similar trap. Overestimating their ability to judge the market, they take imprudent risks. When their analysis is proved flawed, this group refuses to admit their mistakes, clings to their ill-conceived views, and suffers debilitating losses.
The second point is recklessness. When traveling through dangerous waters at night, the Titanic assumed high speeds. Had the ship been moving at a safer pace, the crew would have seen the iceberg. Instead, recklessness impeded the ability to react and led to disaster.
For investors, the lessons are similar. Investing in the markets carries both risk and rewards. You should only allocate capital you are willing and able to lose. All of us know someone who had extra cash that was needed a few months hence, put it in the market to make more money, and suffered large losses. Those looking to invest should understand that allocating capital carries risk and only put into the market funds that will not be needed for at least three years.
Finally, we turn to impulsivity. Newton's third law of motion teaches us that every action has an equal and opposite reaction. The actions of the crew of the Titanic and the resulting outcome reflect this principle. As the ship sped toward the iceberg, the Titanic turned in order to avoid a collision. Doing so resulted in multiple punctures that sank the ship. However, if the crew had done nothing, the Titanic would have hit the iceberg head-on and suffered damage, but would not have sunk. Reacting impulsively led to disaster.
Investors do the same. When a stock price moves dramatically, we feel the need to do something. However, sometimes doing nothing is the right answer. If position sizes are small, the reason for taking those positions is sound, and nothing has fundamentally changed, taking no action is the best course. Since we can never determine each wrinkle in the path of prices, we are better served by allowing time to work to our advantage and not overreacting to each piece of new information.
Analyzing markets, determining the fair value of assets, and executing an investment strategy are difficult. Overcoming inherent behavioral tendencies is even harder. If we remember the lessons of the Titanic we will not be automatically able to avoid these pitfalls, but we will be taking the first step in a long journey.