The Intelligent investor must be dispassionate and detached as well

John Kay, the celebrated Economist is so right in his latest article, but an intelligent investor investing for himself is not necessarily unbiased and devoid of emotions and instincts; that is where a dispassionate adviser scores.

To be concerned when a stock depreciates in value while feeling euphoric when it appreciates are very normal human behaviors while it could be both headed in the wrong direction. A dispassionate adviser with very little emotional attachment to the daily movements would do far better to take the view of what is intrinsically good or bad with the stock. Mr. Warren Buffet is the only exception that he is intelligent and also equally “detached” emotionally with his stock-picks.

It would be another matter if the rest of the populace could get to his level of intelligent and emotional detachment.

This is what I wrote as comment on the article, “How to be your own investment manager”, written by John Kay in Financial Times on last Friday.

The article had numerous examples why investing on your own without the usual help of the experts, like investment managers, could get you earn more on the investments as one could potentially save on the commissions. Investing on the index rather on the individual stocks, or investing in a basket of stocks that resembled a growing economy where you could potentially hedge your bets was the central argument of the thesis.

Well, I beg to differ and it is not because John Kay is wrong, but because there are many other factors why investing on your own (without the help of expert advice) with your own money may not be a great prescription for success.

First of all the thesis must start with the understanding of risk itself. Think of the doctor who has the predicament of treating himself with his own diagnosis. Here he is the prescriber and he is the patient who will respond to the medicine emotionally as well. While the body could respond in a particular way, the mind could be emotionally involved in discovering patterns that do not exist. The mind could be risk averse or could be inclined to taking risks that the usual doctor would not dare to take or it could be just the opposite. Looking at the first response of the body, the patient could actually think the medicine has taken effect or it has not, either of which be wrong, that a patient doctor would wait for more signals.

The same happens with a stock which shows random patterns of behavior which could simply be the result of the market fluctuations responding to daily new information and might not have anything intrinsically linked to the stock. But like the example above, the investor if he is investing with his own money could be emotionally involved into believing otherwise.

The intelligent investor must be emotionally detached as well, to be able to understand the nuances or the patterns that as signals could be distinguished from noise.

This also is the fundamental reason why most entrepreneurs would rather have agents to look after their business who could take dispassionate decisions that are not swayed by emotions or attachment to certain positions. The challenge here to have incentives designed that align the interests of the principal and the agent; a conflict of interest could bring in enormous amount of friction in the process and we have a plethora of examples. So the design remains incomplete.

For an individual investor, stock picking could never be that simple; one could learn throughout the life and could be as much a success as a failure. The odds that an individual stock picker would be successful against the market is anybody’s guess; the real issue is if an individual stock picker could beat the combined wisdom of millions of investors, it could only mean that the market is extremely inefficient, which is a direct contradiction of the efficient market hypothesis. On the other hand the efficient market hypothesis itself has been challenged by many.

Warren Buffet or for that matter every successful investor who could beat the market are those who did not take the random walk but could sense the underlying the value or absence of value in a stock. They could put their own estimates of the value, which was different than the market value as they could challenge the paradigm of the efficient market hypothesis. They did not believe that all information is priced in a stock, or for that matter they would pick up a $100 note from the street believing that there are $100 notes lying out there which have not been picked up.

But to do this requires restraint and emotional detachment. To be able to hold on to a stock that is losing while selling a stock which is going up are not anybody’s cup of tea. It is not normal human behavior to sacrifice the current for the future or to be so future focused that it destroys the current completely.

To be nimble and being anchored simultaneously into the intrinsic elements of a business, while the rest of the system could be influencing the outcome constantly, is not governed by passion or by intellect entirely. It is like running thousand algorithms which are all independent and also mutually exclusive while the relationship between the underlying elements of any stock within the boundaries of an economy cannot be completely distraught.

Investing in one’s own business on the other hand is the easiest option, given that it is the one best understood. No wonder stock buy-backs have been doing so well. But this is not what an individual investor can do, who is not part of the business.

In sum, an individual investor must be intelligent, but he needs to be emotionally detached to the stock he is buying or selling. He will do good if he could tolerate losses by holding or selling, but he would do bad if he is only bent upon making gains at all times.

Being intelligent alone may not make you a great investor.