There They Go Again

“Where do babies come from?” This was the subject of many debates when I was a kid, and the answer was always the same: “An aeroplane drops them from the sky.” Now it’s thirty years later, and no one talks about this anymore. Today’s kids learn the real answer so much sooner than we did.

Where does my monthly investment return come from? Fewer people ask this question than asked about babies thirty years ago, and even fewer have the answer. I’ll give you one hint: it’s not from the sky.

Investors truly make the same mistakes over and over. It may be a new generation of people doing it, and usually they do it in new markets or with new glamorous financial instruments but the behaviour is the same. It rarely happens that the same errors are repeated in successive years. Usually enough time passes by for the mistakes and cries of the past to be forgotten. If you observe with the benefit of the knowledge of history and objectivity you can easily see the patterns.

The past three years have been rife with financial innovations that promise to pay people enough money to be rich and earn a massive monthly income (or salary replacement).

As I read the website posts in 2017 about the new financial innovations that have high and guaranteed returns as their birth right, I find myself saying one thing over and over again “There they go again”.

Why do people repeat the same mistakes?

First, few investors have been around long enough to see the recurrence of trends that existed in the past. And second, organised crowds have always played a role in the lives of individuals, but this part has never been elevated such as at present. This is especially true when the good times are rolling. There’s a tendency to ignore the rules of the game, when following them leads to uninspiring returns. What are some of the behaviours that we have observed lately?

This is new and different

The most dangerous thing in investing is believing that the rules of the past are old-fashioned and new ways are required to create wealth. It is well documented that when investors take a trend to excess, it does busts eventually.

I will never lose

“Well you never say never and you never say always.” Many investors are still struggling to stop themselves from a believing the most fairy-tale story of all: an investment without risks. I will say it now: there is no such thing as a risk-free investment or one that guarantees to deliver high returns as its birth right.

The future will look like the past

From time to time, a colourful mix opportunists (who often don’t understand what they are getting involved in) and greed convinces people that the current environment will continue forever. But usually things will get bad at some point and they’ll be a creation of new market characteristics. Just like in chemistry when certain elements are brought into contact, they combine to form a new body possessing properties quite different from the original.

The stock market is not a zero sum game

A zero-sum is a situation in which one person’s gain is equivalent to another’s loss. A zero-sum game may have as few as two players, or millions of participants. So for every rand that you win in a stock market, some other investor loses. It’s that simple. So it’s highly unlikely for 5 000 strangers in one trading room taking different trading positions to consistently be winners in the stock market, assuming they are playing in the same market. If they follow the same strategy (which rarely happens), then wins and losses will affect them equally.

The storytelling is simple

By this I mean to make fun of investors tendency to believe stories that seem true on the surface but ignore how the stock market work. These include “I’m about to share with you the biggest secrets of making money in the stock market” and “Make R10 000 a month from the stock market”. Buffett says “The market, like the Lord, helps those who help themselves,” “But unlike the Lord, the market does not forgive those who know not what they do”. So in your hunt to generate decent returns, invest in things you understand with a certain level of confidence and that are within your circle of competence.

Past returns will look like future returns

There is no asset class that will do well simply because it exist. An example is property. People said “You should buy property it always goes up in value” and “You should buy property they are not making any more land”. But nobody tells you that done at the wrong price and time property investing doesn’t work. They key is who likes the investment now and who doesn’t, future prices will be determined by whether more people demand the asset or not.

It sounds too good to be true, but I don’t want to miss out

There’s been many times when people knew something was unlikely to work forever but jumped on the bandwagon anyway. Usually they do this because they think there’s a bit more left and watching from the side-lines while everyone gets rich becomes too painful a pill to swallow.

I’ll get out before it stops working

In the stock market there is no referee that blows the whistle to prepare you for oncoming danger. Nobody ever asks how they’ll know when to sell before others know, or who will they sell to if everyone is also trying to sell at the time.

We have secrets that are used by professionals

There are no secrets in the stock market! Warren Buffet, the world’s most successful investor has his every investment success recipe published in every book. Similarly, in the food lab recipes are effective as cooking guides; they provide a method from a list of ingredients to a finished dish. But chefs who rely only on strictly ordered formulas miss what is really important. Do I need to add more or less of an ingredient to satisfy my personal taste? That is because recipes assume a certain baseline knowledge, just like a GPS won’t tell you to stop at a red traffic light.

The mistakes listed above express wishful thinking, an inevitable part of human nature. They come from our desire to ‘hope for the best’ and ignore any negatives in our pursuit to make money. When individuals are under extreme financial pressure, as I think many are now, they sometimes behave irrationally. In the stock market excessive confidence sets the stage for disappointments.