Monday, March 30, 2015

Behavioural finance: Psychology of the astute value investor

“All of humanity's problems stem from man's inability to sit quietly in a room alone.”
- Blaise Pascal

Charlie Munger espouses a concept called the latticework of mental models. This section is my understanding of that concept applied to value investing. Robert Cialdini’s book “The psychology of influence” is also a wonderful read and probably encapsulates most of what one needs as the basis of behavioural finance. I already had this book on my bookshelf somehow and then started seriously reading it when I heard Munger recommend it on his 1995 lecture on "The psychology of human misjudgement". The psychological element of value investing is the most important advantage that you have. There are several intelligent investors who do not raise capital to manage for others for the simple reason that they don’t want their investors to liquidate at exactly the wrong time.

At the time of the 2008-2009 market crash I had read enough about value investing to know that it was a good time to get into the markets. The Dow Jones Industrial Average fell from 12.4K high in 2008 to below 8.3K in 2009. During the course of several discussions I had run through the Buffett quote about real investors being happy when stock prices fall because over next few decades they are likely to be net buyers of stocks than sellers. I even thought about buying Berkshire stock at the time but for some strange (probably behavioural reason) I never did invest any money into the US markets. Understanding the biases that separate the impatient from the rich is an integral part of practicing the art and science of value investing. I will be posting articles on each of these biases that Charlie & Cialdini talk about and put them into perspective for you. Hope you enjoy these articles on human irrationality.

At the time of this writing the NIFTY is down around 7% from its peak and this is a big fall after a period of monotonic rise of the index owing to the investor exuberance towards the new government in India. If this slide continues several opportunities should bear fruit.