Friday, December 2, 2011

Why investing is unnatural!

Nature has bestowed all living organisms with certain instincts. Its hard-wired into the very being of organisms. We humans are no exception. And since we have turned out to be the alpha organisms on this planet, we have a bit more instincts than others, some smarter, some dumber!
Well, instincts are natural. They are like reflex actions and we are, by our very nature, slaves to them. Imagine that you have your face against a strong glass cage, housing a snake. Now, if the snake strikes, you will instinctively recoil back, inspite of knowing that the cage is pretty strong and there is no real danger to you.
Let us try to relate some of our instincts to the discipline of investing. I find that most of our natural instincts are quite useless in investing. Investing is a slow, deliberate, disciplined and a well thought out process, not an instinctive one. I am talking strictly about investing here and not 'trading'. (You know what I mean!)

Instinct to get away from danger
This is an omnipresent instinct in all organisms. Unless you yourself are the danger, you will try to run away from danger! Going against this instinct is quite something! Why do we admire our soldiers and firefighters? They fight every instinct in their body and mind while doing their work and actually run towards danger!
Now what happens in investing? History tells us that the best investment opportunities have been found when everything around is 'dangerous'. Recent memories of Mach 2009 are still fresh in our minds. That was the dangerous time when quite a lot of stocks were quoting at irrationally low prices. If investors run away from it, they lose some really good opportunities.

Instinct to avoid pain
This is a very pervasive instinct in humans. (Just ask all the pharma companies manufacturing pain-killers!) Rational humans will not deliberately do something which can cause themselves pain. The ones who do sometimes get locked up in mental institutions! Unless totally unavoidable (like, lets say, a medicine injection), we all would honestly like to avoid pain and would be willing to do anything for that.
In investing, people experience mental pain, seeing their portfolios in red. To avoid the same, they wait for the market to bottom, where they will buy truckloads and probably retire quick! Well, it just doesn't happen. You will know the bottom for sure, only after it has come and gone. Pain in investing is common. Your portfolio can give you anguish for short-medium periods of time, when things are irrational. If you have conviction and have done your homework, the short term pain is worth taking, for the long term gain.

Instinct to survive
The instinct to survive is probably the most prevalent of the base instincts. We have all heard the story of the monkey and her baby trapped in a well. We all will do whatever it takes to survive, however irrational or illogical it might be.
Does this work the same way in investing? Imagine a person who has lost a lot of money in the markets. He is close to losing everything. If you go and tell him a hot stock idea or some F&O strategy, which can 'recover his losses' fast, chances are he will jump into it without much thought or analysis. The desperation to come out, to survive is extremely prevalent. But here, he might end up hastening his death, instead of managing to survive. The instinctive brain needs to be given a rest sometimes!

Instinct of greed
Many of you will argue that this is no instinct! But I believe it is. We have an instinct to want more of what we like. Now, this 'more' may not be good/healthy for us later, but still it gives us the required pleasure at that moment and we are fine with it.
Well, we all know what greed can do to us in investing, so I will not talk much about that. Gordon Gekko famously said 'greed is good', but he also (infamously) went to jail! This is another instinct which needs to be controlled.

Instinct of instant gratification
Humans look for shortcuts! Our mentality is such that we get attracted to anything which has the potential of giving us fast results. Something which requires longer time and higher effort is something which does not appeal!
In investing, the same thing holds true. Why do people get attracted to the get-rich-quick MLMs, why are the 'hot stock tips' so popular? Instant gratification! Well, there is nothing instant about investing. Businesses take time to perform and so does your investment. Our 'instant' instinct needs to be strictly controlled!

Instinct to form groups
Since ages, humans have lived in groups for a variety of reasons. And it has worked fine. We have a natural tendency to not be alone, if we can help it. Sometimes, any company is good company. (No pun intended!)
This same instinct may not necessarily work in investing. Investing is quite a lonely exercise! If we do what the crowd is doing, the decision may not be correct. The best opportunities to buy have been when the crowd is selling and vice-versa. Always going with the consensus may not be great for your investing health! Mauboussin famously equated fund managers with zebras and is something worth reading.

Instinct of aggression - the alpha male!
The instinct to show that you are the aggressive, happening guy is ever pervasive. The dopamine kick that aggression gives is quite an experience.
Imagine an intraday trader talking about his exploits. How he had the nerves of steel and the aggression to fight the market and come out on top. This aggression may, of course, not work every time. Undue aggression at a wrong moment may be enough to wipe you out for ever! Now imagine a longer term investor talking. :-) It may of course sound boring compared with the flamboyance of  the aggressive trader! Investing is not about being aggressive just for the heck of it. The investor will let loose this instinct of aggression at rare, opportune moments. Rest of the times, this instinct needs to be carefully controlled!

Instinct to justify
I honestly think that this is one instinct prevalent only in humans. Imagine this: a cheetah is running after an antelope but he doesn't catch it. He blames it on a small pebble that tripped him while he was running! Seems very funny even to imagine right? Now imagine yourself trying to finish work before a deadline. If you can't, you will have a hundred ready excuses, which prove that 'it was not my fault'. Happens to us all! Its instinctive.
Justifying is perhaps the most dangerous thing in investing. Why did I make a loss? Coz the market itself collapsed. So my stock, which is an amazing company, also collapsed for no reason. Why did I make profit? Coz I am goddam smart! Not coz the market rose! Justifying ourselves in our brain does not help us learn from our mistakes, coz it tells us that we are not making any! Something to be avoided at all costs!

Instinct to do activity
This is another instinct hardwired into all of us. We all have the constant need to keep on doing something. Why is meditation so difficult? Its because its unnatural to sit quietly, with a blank mind!
This is prevalent in investing too. The need to 'do something' is so pervasive. Of course, its not the best of ideas to keep on doing something all the time. There are times to do nothing and there are other times to do everything! Majority of the times, the need to do activity needs to be controlled.


So what can we infer and learn from all this? 

  1. I can write really long articles!
  2. We have certain instincts hardwired into our brain.
  3. These instincts may not work in the process of investing. Relying on these instincts may prove disastrous.
  4. There is no such thing as a 'born investor'. (in my view)
  5. We need to train our brain to control our instincts while investing. Investing has to be a thought out and logical process and not an instinctive one. Controlling instincts is very hard, I agree, but no-one said investing is easy!

Hope you did not instinctively ignore this article, seeing its length! :-)

Cheers and happy investing!

17 comments:

Raunak Onkar said...

Hi Neeraj,
Wonderful post.

You can perhaps add these two corollaries too:

- Instinct to create logical structure: Constant urge to create structured thoughts to make sense of the world. This is very dangerous because we tend to assume that we know all the variables in play. Basing decisions on few known variables, calculating the odds & creating the big picture out of it plays a big role in investing. Not all outcomes in investing are logical/linear as expected.

- Instinct of narrow focus: We only have the ability to pay attention to a very limited number of things at once. In any business there are many variables that need to work to get good, sustained results over time. Managements who want to mislead tend to make us focus on the wrong areas diverting attn from the really screwed up bits in the business. We can be easily misled. In investing we have to be consciously aware of this possibility.

Neeraj Marathe said...

Hi Raunak,
Nice to hear from you man..wonderful inputs..thnx!
Cheers!
Neeraj

a common investor said...

Hi,
am eager to know if you support the idea of passive/index investing as the most sensible thing to do for a lay investor (or for that matter, even the 'pros' ;). your previous articles and now this one, suggest so, tome atleast.
a common investor

Neeraj Marathe said...

Yessir,
I do. Low-cost index funds are an ideal option for people who do not have time to look into individual stocks, perhaps in SIP mode. The only requirement would be control over emotions and strict adherence to a pre-decided plan..
cheers!
Neeraj

Dhwanil said...

Hi Niraj,

Indeed a very engaging and thought provoking article. You have correlated some innate human instincts with investment behaviour. Kudos to you!

Neeraj Marathe said...

Thnx a lot Dhwanil,
Glad you enjoyed it :-)
cheers!
Neeraj

Saurabh Shah said...

Awesome Article especially the inference part. I loved the article man. Wonderful and unique read man!!!! cheers and thanks for sharing !!!

Neeraj Marathe said...

Thnx Saurabh..glad to hear from you after a long time. Howz life? Do be in touch :-D
cheers!
Neeraj

Manish (KulMan) said...

Wonderful write up. I liked it instinctively!

Charles Darwin (and now Neeraj M) says: "the very essence of instinct is that it's followed independently of reason."

Unknown said...

Hi Neeraj, Excellent write up. Am trying to avoid especially the last one instinct to do activity.

Ramakrishna

Neeraj Marathe said...

Kulkarni Saheb and Ramakrishnaji,
Thnx a lot..glad u enjoyed it!
cheers!
Neeraj

JM said...

Dear Neeraj, Your thoughts on thoughts are giving us lots of thoughts. Well, u r becoming better with your thoughts with each article. Congrats. Janak Merchant

Neeraj Marathe said...

Hey thnx a lot Janakbhai..
cheers!
Neeraj

sagar said...

Excellent Article Neeraj.
I'm one of the person following your cult :)

Neeraj Marathe said...

Cult!!
:-D
Neeraj

Rajesh.v said...

hi,

this is one of the best posts i have ever read

Neeraj Marathe said...

Thnx a lot Rajesh..glad you enjoyed it..
cheers!
Neeraj