Myth Solved – Why Investing in Stocks is NOT Gambling: How many times have you been discouraged from investing by being told that it is just another name for “Gambling”? For some of us if we had a dollar every time we heard that we’d have to classify it as a source of income. In this article, we take a closer look at the century-old myth and debunk why investing in stocks is NOT gambling.
But before jumping into their differences let us understand what the two words investing and gambling mean.
What is Investing?
The basic purpose of investing is directing your liquid capital towards companies that need it. This however is done with the intention of generating income or profit. But along with this while investing one’s money into a company one also boosts the wealth of the economy as it helps them commit that capital to assets to increase productivity, aid growth, hire more people, etc.
This leads to an increase in the value of the company and an increased value of our investment in it. Investing is not devoid of risk which depends on the factors like the level of research, the period of investment, etc.
Gambling, also known as betting is wagering money or something of value on an event whose outcome is uncertain. This is done with the aim of winning the prize money. Some examples of gambling are Lotteries, Card games(poker, blackjack), Slot machines, etc.
Differences between Investing in Stocks and Gambling
Although both of them include a series of decisions, risks and are done with the aim of profitability they have a lot of key differences.
1. Level of Control
Investors and gamblers have varying possibilities of mitigating their losses. After deciding how much they want to invest, investors can choose the asset class they want to invest in which have varying levels of risk. For example assets like bonds have low-risk low returns whereas stocks have a high risk with the possibility of a higher return.
In addition, the size of the companies also offers varying risks, eg. blue-chip stocks have lower risk in comparison to small-cap stocks. In addition, investors also have the option to save their capital. If they find out that their investment has begun making losses they can always decide to sell their investments.
Gambling on the other hand is a sum-zero game. Out of all the money pooled it is only a few or in some cases only one person who wins big at the expense of others. It also diminishes the possibility of you winning your capital back or limiting losses. Take the lottery ticket for eg. if you do not win the lottery you have lost the complete Rs.1000 capital you poured into the ticket.
2. Environment
The environment differs massively between the two. Investing has been made so accessible that one can pursue a career in trading from the luxuries of their homes and investing can simply be done through smartphones.
Gambling on the other hand is a completely different ball game. Although there are online means and lotteries casinos still occupy the greater share. Casinos bring shows, food, drinks, and a lot more to the table. Most casinos are designed in order to play on the weaknesses of human psychology. These include glittering lights, music, and free drinks, all these set at dulling your senses, weaken your decisions, and most importantly keep you there all night long.
3. Stock Exchange vs. The House
For investors stock exchanges simply serve as a medium or platform for investing to take place. They charge minimal amounts for every trade and strive for increased efficiency.
The house in gambling refers to casinos, bookmakers, slot machines, etc. It is a common term in gambling that the house always wins. The games generally have different varied edge over the players with benefits going to the house. In card games, the advantage for the casino might only be 0.5%, but certain types of slot machines might have a 35% edge over a player—other games fall somewhere in between.
4. Time Factor
In investing the longer you stay the lower your odds become of making losses. This is the exact opposite of gambling. it does mean that the more you play, the more the math works against you. There are greater chances of you walking out of the casino with less money than when you came in. Take the examples of slot machines, they have odds ranging from one in 5,000 to one in about 34 million chance of winning the top prize when using the maximum coin play.
The period of participation also differs here, when investing your participation can actually span decades. At the same time even if the shares may not increase significantly in value investors are still rewarded for staying invested in the form of dividends. When it comes to gambling once the game or race or hand is over, your opportunity to profit has gone.
5. Information
Knowledge is power! Information is important for both investing and gambling but it is available in varying amounts. Investing is abundant with information that is ready to use. Company earnings, financial ratios, research analyst reports, can be easily found online before investing. When it comes to gambling the information available is extremely limited and worse it is not always quantifiable.
In this post, we discussed why investing in stocks is NOT gambling. Despite a number of differences stock market investing can still become a gamble for many. This is because of investing without research, speculation, investing all your money ina single stock, etc.
Investing after doing a thorough study is rewarding in the long term whereas flipping a coin to select a stock makes it a gamble. Although the stock market is hard to understand it sure does make much more sense than a casino.
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
A Guide to Qualitative Analysis of Stocks for Beginners: When you think about analyzing a strong company, the first picture that comes to your mind is most probably about an individual with high aptitude locking himself in and crushing numbers all day long. Moreover, the numbers like Total Revenue, Operating, Profitability, Margin Net Profit, etc might come in the notice. But is that all there is to investing?
Today, we take a look at the other side of the coin, known as qualitative analysis. Here, we’ll discuss what exactly is the Qualitative analysis of stocks and moreover, how you can perform it.
What is a Qualitative Analysis of Stocks?
Qualitative analysis is the use of non-quantifiable information in order to judge the investment prospects of a company. This information includes quality of management, the satisfaction of various stakeholders, ethics, brand value, etc. This is also known as soft data. This soft data deals with factors that are intangible.
What we are accustomed to is known as quantitative analysis. Here the focus is on numbers, ratios derived from statements like the Income statement, balance sheet, and cash flow statement. The biggest factor of differentiation is that quantitative data can be crunched by artificial intelligence or simply put computers. Qualitative analysis on the other hand requires a human touch.
(Image Credits: AZ Quotes)
Why Qualitative analysis of Stocks Important?
Even though we might be sitting behind a computer screen and viewing a mixture of numbers that make up important company information. It is important to remember that ultimately it is people who run these companies and not numbers. It is humans who ultimately create and buy the services or products offered by the company. Hence it is not simply possible to only look at the company as a collection of numbers.
Take for example Coca Cola. The company manages to sell 1.8 billion bottles per day. If we just look at numbers like this the company could be the greatest to ever exist. But not many would have foreseen the consumer concerns changing to consider health prospects over
How to Perform Qualitative Analysis of Stocks?
Here are the aspects of a company form part of the qualitative analysis of stocks and what investors need to look for before investing:
1. Company Management
It is very important to take into account who leads the company. These include CEO’s, Board of Directors, Chairmen, etc. If tomorrow a new CEO is being appointed analyzing if he is the right fit for the company goes a long way. One would always prefer someone who is already experienced in successfully running a company in the industry over an individual who is new to the industry.
Further background checks would include assessing their education, management style, etc. For eg., a CEO who does not believe in automation or further innovation could be a potential risk to the company.
However, it is also important to take these factors as conclusive evidence. Take for example if one were to judge Apple in its nascent stages by looking at Steve Jobs solely on the basis of educational qualification one would dismiss Apple as a potential opportunity. But Steve Jobs was a marketing genius second to none.
One can also judge the competence of the management team depending on how they react during a crisis. Take the example of Sony. In 2011 the company suffered a data breach of 77 million PlayStation users. Instead of trying to cover it up the CEO apologized personally and customers even were given a free subscription to PlayStation Plus and identity theft insurance.
2. Employee Satisfaction
Employee satisfaction is crucial as only then will their top services be carried forward to the customers. One of the means through which we can assess this is by observing the employee turnover ratios of the company. A company with a high turnover ratio could be a sign of an unhealthy or toxic work environment.
This is why companies often provide employees with the best amenities and a strong independent HR to look after their concerns.
3. Supplier Satisfaction
It is also very important that the company also ensures that they treat their suppliers fairly. As a healthy relationship with suppliers goes a long way. One example could again be that of Amazon. The company cloned the tripod product of a small company using their platform.
They however did not stop by turning themselves into competitors they also banned the company from using the platform. News like this only puts companies in a negative light.
Every action that a company takes is in one way or the other geared towards customer satisfaction. We all have seen examples of how seriously even tweets on social media platforms are taken in order to protect the image of the company. Nobody wants to deal with a company that deals horribly with their customers.
As reported by Investopedia between 1994 and 2007 companies that please their customers are shown to create about four times the wealth.
5. Other factors
There are numerous other factors that also play an important role in qualitative analysis. These include the competitive advantages of a company, patents it possesses, brand value, moats in its industry, etc.
Although these factors may not be exactly quantifiable they still form a very important role in the analysis of a company.
6. Institutional Participation
Whenever large investments or private equity groups invest in a company, they do so after taking into account all the quantitative and qualitative factors. This means that they have already done their research. Hence companies having large institutional investors is a positive sign.
The information needed for quantitative analysis however is hard to come by. When it comes to numbers computers can be programmed to deliver results or analysis in a fraction of seconds. Qualitative analysis of stocks on the other hand hard and time-consuming to analyze.
Another factor is analyzing what information is relevant and what isn’t. Some sources include company websites, business publications, annual reports, shareholder meetings, etc. A well-rounded analysis is no easy task but is only complete when both quantitative and qualitative factors are considered. Let us know about your experience in the qualitative analysis below in the comments. Happy Investing!
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
List of Most Frequently Used Trading Animals in the Share Market (Bull, Bear, Stags, Wolves & More): Have you watched the movie ‘The Wolf of Wall Street” starring Leonardo DiCaprio as Jordan Belfort? If yes, then have you wondered why he has been referred to as a wolf in the movie? What’s an animal doing in the stock market-based movie?
Well, Animals in the Stock Market are commonly used terminology to define specific characteristics of the type of traders or investors or market scenario. In this article, we are going to discuss 11 of such most commonly used animals in the stock market. Please read the article till the end as there are some bonuses in the last section of this post.
11 Most Frequently Used Trading Animals in the Share market:
Here are the eleven most frequently used animals in the share market by stock analysts or the authors of investing books.
1. Bulls – The Optimistic
The bulls represent the investors or traders who are optimistic about the future prospects of the share market. They believe that the market will continue its upward trend. Bulls are the ones who drive the share price of companies higher.
2. Bears – The Pessimistic
Bears are the investors or traders who are totally opposite of the bulls. They are convinced that the market is headed for a fall. Bears are pessimistic about the future aspects of the share market and believe that the market is going to be in RED. Mostly, bears are the reasons for getting the share prices lower.
Quick note: The bulls and bears are often used to describe the market condition. A bull market is a scenario when the market appears to be optimistic and climbing new highs. On the other hand, a bear market describes a market where things are not good and appears to be a long-term decline.
3. Rabbits
The term rabbits are used to describe those traders or investors who take a position for a very short period of time. The trading time of these traders is typically in minutes.
These types of traders are scalpers and trying to scalp profits during the day. They do not want overnight (or long-term) risk and just looking for an opportunity to make some quick bucks for the market during the day.
4. Turtles
The turtles are typically those investors who are slow to buy, slow to sell, and trades for the long-term time frame. They look at the long-term frame and try to make the least possible number of traders. This kind of investor does not care about the short-term fluctuations and most concerned with long-term returns.
5. Pigs
“Bulls make money, bears make money, pigs get slaughtered”
These investors or traders are impatient, willing to take high risk, greedy, and emotional. The Pigs don’t do any kind of analysis and always look out for hot tips and want to make some quick bucks from the share market. Pigs are the biggest losers in the stock market.
6. Ostrich
Ostriches are those kinds of investors who bury their heads in the sand during bad markets hoping that their portfolio won’t get severely affected.
These kinds of investors ignore negative news with an expectation that it will eventually go away and will not impact their investments. Ostrich investors believe that if they do not know how their portfolio is doing, it might somehow survive and come out alright.
7. Chickens
Chicken refers to those investors who are fearful of the stock market and hence do not take risks. They stay away from the market risks by sticking to conservative instruments such as bonds, bank deposits, or government securities.
8. Sheeps
Sheep are those kinds of investors who stick to one investing style and do not change according to the market conditions.
They are usually the last ones to enter an uptrend and the last one to get out of a downtrend. The sheep like to be on the side of the majority (herd) and follow a guru. They are not interested to develop their own investing/trading method.
Dogs are those stocks that have been beaten down by the market due to their poor performance. Many financial analysts look into the dog stocks closely as they expect these stocks to recover in the upcoming days.
10. Stags – The Opportunistic
This kind of investors or traders are not really interested in a bull or bear market. They just lookout for opportunities. They are neither bullish nor bearish.
For example, Stags can be the traders who buy the share of a company during its initial public offering (IPO) and sell them when the stock is listed and trading commences. They do stagging with the hope to get listing gains and hence these individuals are called stags.
11. Wolves
Wolves are powerful investors/traders who use unethical means to make money from the share market. Mostly, these wolves are involved behind the scams that move the share market when it comes to light.
For example- Harshad Mehta can be considered as the wolf of Dalal Street. He was charged with numerous financial crimes that took place in the Securities Scam of 1992. Similarly, the famous Hollywood movie ‘The Wolf of Wall Street’ depicted Jordan Belfort, who was convicted on charges of stock fraud in his penny stock operation and stock market manipulation.
A lame-duck is a type of trade or investor who trades and ends up with a huge loss. Lame ducks have either defaulted on their debts or gone bankrupt due to the inability to cover trading losses. The phrase can be traced to the early years of commodity trading and the development of the London Stock Exchange during the mid-1700s.
13. Hawk & Dove
Hawks and doves are terms used to describe the types of policymakers who take critical stances on different economic situations. It basically suggests the sensitivity of a policymaker is towards an economic situation. A ‘hawk’ wants a tough stance in an economic situation, whereas a ‘dove’ wants to be easy with it.
14. Whales
These are the big investors who can move the stock price when they buy or sell in the market. You can make a lot of money if you trade alongside the right whale.
15. Sharks
Shares are those traders who are just concerned about making money. They get into the trades, make money, and exits the share market. The sharks have very little interest in big complicated methods of making money from the market.
16. Dead Cat Bounce
The dead cat bounce slang is used to refer to a temporary recovery during the bear run. Either it could mean a temporary upswing of the market in the midst of a bear run or it could refer to the particular stock behavior.
Interestingly, this phrase has been employed from the explanation that if you throw a dead cat against a wall at a high rate of speed, it will bounce – but it is still dead.
17. Dogs of the Dow
This is a popular investing strategy where the investors select the 10 highest dividend-yielding blue-chip stocks from the Dow Jones Industrial Average (DJIA) every year. The main reason to follow the Dogs is that it presents a straightforward formula designed to perform roughly in line with the Dow. This concept was originally published by Michael O’Higgins’ in his book, “Beating the Dow,” in which he also coined the name “Dogs of the Dow.” Similar to this concept, Dogs of the Sensex is used in India.
That’s all. I hope this post on trading animals in the share market is helpful to you. Let me know what kind of trading animal you are- in the comment box. #HappyInvesting.
Hi, I am Kritesh (Tweet me here), an NSE Certified Equity Fundamental Analyst and an electrical engineer (NIT Warangal) by qualification. I have a passion for stocks and have spent my last 4+ years learning, investing and educating people about stock market investing. And so, I am delighted to share my learnings with you. #HappyInvesting
Understanding Cognitive vs Emotional Biases: Every day of our lives is filled with decisions we take, some may be important and some are effortless as a result of habit. Unfortunately, these decisions are influenced by the observations we make, the experiences we’ve had, how we’ve been conditioned to reach, etc.
Even when we are grocery shopping we favor some products over the others simply because we like the celebrity that advertised them. Investors suffer from these biases too. His may not come as a surprise as investors often experience a roller coaster of emotions while investing or trading.
Today we take a look at common investment biases that exist. Here, we’ll be covering Cognitive vs Emotional Biases while investing. We do this with the aim of studying what leads to wrong decisions as this would assist us in avoiding huge future losses.
Cognitive vs Emotional Biases
The economic and financial theory is based on the assumption that individuals will act rationally and consider all available information in their decision-making process, and that markets are efficient. But this is rarely the case. Studies have shown that 80% of individual investors and 30% of institutional investors are not always logical.
This brings us to Behavioral finance. Behavioral finance is a branch of economics that explains the irrational decisions of an investor. These irrational decisions are a result of strongly ingrained biases that exist deep in our psyche. These biases have been classified as cognitive and emotional.
What is Cognitive Bias?
Cognitive biases are generally related to the way a person is wired to think. These biases are said to arise from statistical, information procession, or memory errors that cause the decision to deviate from a rational decision. Because of this, they are also easy to correct with better information, education, and advice.
Take for example security of a hotel hosting a celebrity event allows a Lamborghini in, based on the assumption that one of the celebs has a Lamborghini. This is a flawed approach as this may not necessarily be true.
Types of Cognitive biases
Here are a few common types of cognitive biases in behavioral finance while investing:
1. Confirmation Bias
When you get into arguments, have you ever tried to google facts to support your argument? Confirmation bias takes this a step further as people with confirmation bias only seek out evidence that confirms their beliefs and ignore evidence that contradicts them.
Say for eg. after some research you arrived at the conclusion that Reliance is good for investment. In order to support this, you only look for confirmation from studies, research in order to support your argument without even considering any opposing argument. Your decisions are now blurred due to confirmation bias. The easiest way to counter this would be to consciously gather the information that is contrary to your opinion.
2. Gamblers Fallacy
Humans make an effort to ensure that everything makes sense to them. This often leads them to look for patterns in areas where they are nonexistent. Nobel Laureate Daniel Kahneman is one of his studies asked his participants “Which of the following sequences is more likely to occur when a coin is tossed – HHHTTT or HTHTTH?”. The majority of the people answered that the second sequence is more likely to occur. This was flawed even with people already knowing that in such a situation a coin toss held a 50-50 chance.
This happens in investing as well, people tend to invest in funds simply because they have performed well for the last 5 years. Investors may perceive this as a trend that may carry into the future as well. If a study is done statistically it may make sense but past events don’t connect to future events. If the market has been rising for the last 1 month continuously it is not necessary that it will fall tomorrow. Shorting the market only based on this information is flawed.
People are more comfortable when things remain the same and are generally averse to changes. In investing this may be seen as investing only in industries that you seem to understand. Although a deeper understanding is necessary in investing it becomes a hindrance when people do not further their appetite to educate themselves further. This would limit their profit potential only to certain opportunities.
4. Negativity Bias
This occurs when investors give more weight to bad news over good news. When corona broke out in the country in Feb-March the markets began their bearish trends. After a few months, however, the markets resumed with bullish trends. Many investors missed this rally due to negative news. This bias can diminish the possibility of rewards.
5. Over Confidence Bias
A person who possesses this bias believes that his cognitive abilities and skills in the investment field are better than that of others. They also may not necessarily be in investing as a whole. A person working in the steel industry may believe that he has a better ability to trade in steel companies because he is from the same background. These investors overestimate their ability and the control they have over the markets. They also reduce the time required to assess risks.
When investors are overconfident in markets it generally leads to excessive trading. This leads to bubbles in financial markets. Securities here are bought at high prices and later sold at low prices. These traders/ investors underperform in the markets as they overlook various factors that affect their performance.
6. Bandwagon Effect
One of the greatest investors in the world, Warren Buffet attributes much of his success to resisting the bandwagon effect. Here investors feel better when they invest along with the crowd, this also adds to their confirmation bias.
What are the Emotional Biases?
Emotional biases stem from feelings, perceptions, beliefs about elements. Unfortunately mixing emotions and investing often leads to bad decisions. Here basically the investor’s brain is distracted due to his emotions. These biases are generally tougher to fix in comparison to cognitive biases.
Common Types of Emotional Biases
Here are a few common types of emotional biases in behavioral finance while investing:
1. Loss Aversion Bias
One of our aims in investing is to avoid losses. But this has become such a big part of our nature that we try to avoid losses even when we know that by doing so we are causing more harm. This was highlighted in the disposition effect. This term was coined by economists Hersh Shefrin and Meir Statman. The disposition effect is the tendency of investors to sell winning positions and hold onto losing positions.
Take for example your portfolio includes security that has recently started making losses and is soon to hit rock bottom. But you are still holding it hoping it makes a rebound. Investors here are soo averse to losses they cannot sell a security to avoid further losses. The rational thing to do here would be to sell the security and redirect the investment into quality stocks.
2. Self Attribution bias
When investors attribute the success of outcomes to their own actions and bad outcomes to external factors they are said to possess self-attribution bias. When their investments increase in value the investors claim that it is self-attributed ignoring other factors that may have been in play. But when the stocks decrease in value it is due to external factors.
Investors who possess this bias assume that the asset they own is more valuable than what they do not own. This may lead him to hold onto securities even when there are brighter opportunities elsewhere.
Closing Thoughts
Today, we covered the difference between Cognitive vs Emotional Biases and how they affect your investment decisions. Every investor is likely to portray some bias or at times both cognitive and emotional. Being humans there is no way that these biases will be eliminated. But understanding that they exist and that we possess them is the first step in countering them. We can then include rules in our strategies that counter these biases.
One rule could be to sell a security if it makes a 15% loss irrespective of any argument. Following this threshold of 15% would require overriding our emotions. Successful investors however have realized the importance of keeping their biases in check. Happy Investing!
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
Hindsight Bias Definition and Explanation: How many times have you caught yourself or others throwing around the term “I knew it would happen” or ” I told you so” after an event has occurred? This could be post cricked matches or when the villain is finally revealed in a movie or even in the investment world.
Today we’ll cover Hindsight bias and take a look at this “knew it all along with phenomenon” from an investment perspective and the dangers it may pose to you.
What is Hindsight Bias?
Hindsight Bias or Creeping Determinism is a common misconception where people refer to past events and assume that these events are more predictable than they actually were.
Here the individual would claim after the event that he/she knew the outcome of the event before it actually happened. This leads an individual to believe that they could possibly possess a special talent when it comes to predicting the outcome of similar events in the future.
These biases have affected humans throughout history where even historians would be biased when it came to describing the outcomes of battles as they let the knowledge of the outcome influence their description. This bias has been noticed in various situations that include politics, scientific experiments, sporting events, etc.
Although the phenomenon was prevalent, studies only began in the 1970s when psychological research emerged on the topic which soon went on to be studied in behavioral finance. Researchers believed that this bias occurs as our brain tends to draw connections anytime we learn something new with all the other information that we already know. This leads us to look for patterns prior to every result.
Studies have found the following 3 variables to be common among people who suffer from hindsight bias
– Cognitive
People tend to distort or even misremember their earlier predictions about an event.
– Metacognitive
When individuals go back and understand the process that led to the event they feel that it is easily foreseeable.
– Motivational
This stems from people’s belief that the world is a predictable place. Believing that if certain events occur in a certain order makes the outcome inevitable is comforting to many.
For example, if we take a look at the 2008 Recession considering the subprime loans if we were to speak to anyone in the investing world the general consensus would be that the signs were evidently making the event predictable. However, if we were to take a look at what actually happened we would find that the investors who actually tried to drive attention towards the nearing crisis were either ignored or laughed at. Financial bubbles are generally subject to hindsight bias.
Hindsight bias has the ability to affect our investment decisions just as the bias would affect our predictions in other aspects be it cricket matches etc. Investors are put in a pressured environment when surrounded by stocks. This is because missing potential purchases or making bad stock investments generally involves sacrificing years of accumulated wealth. This further pressures them to accurately time stocks always.
In adverse conditions when their stock investment may have declined they may even look back and convince themselves that they saw it coming. This is particularly dangerous because if similar patterns repeat themselves in the future they make take decisions based on their faulty predictions which are not backed by research.
This can be dangerous as even if they might be right due to luck they may go on believing that they earned that success. It may lead to them being overconfident with the belief that they possess foresight or intuition. This may encourage them to take up unnecessary risks in the future which may be destructive for the investor.
Following are some of the traits of investors who may suffer from this bias
They generally overestimate their intelligence. This clouds their decision making which eventually leads them to take up riskier decisions.
Investors who possess this bias constantly blame their advisors or investment managers for losses but when it comes to trades where they make profits they feel entitled to the praise. These investors also at times go ahead and label others who may have made unsuccessful decisions.
Phrases like ” It was meant to happen” are often thrown around.
Investors with hindsight bias often look for the expected outcome in any decision they take. This is flawed as firstly their decisions are not backed by research. Also they often only remember the big unexpected event that led to the outcome the last time and not the multiple small events that affected the outcome in other instances.
How can investors avoid Hindsight Bias?
Investors can avoid being trapped by their own psyche by following some simple remedies:
1. Taking decisions based on research
Sticking to objective analysis presents the investors with the pros and cons. Based on these the investor may go ahead and take the most appropriate decision.
2. Envision both the best and worst possibilities.
Investors with hindsight bias already look at the profitable future they may have based on their decisions. Generally, when we are looking at a favorable future we look for information that fits this narrative. Researchers Roese and Vohs suggested that in order to counteract this bias one may consider mentally reviewing potential negative outcomes as well which would allow people to gain a more balanced view. Envisioning the negative also helps us plan for the unexpected.
3. Maintaining an Investment diary
Investors can maintain an investment diary. Here the investor should map all the investment decisions, the reasons behind these decisions, and their respective outcomes. This would also help the investor learn from both his mistakes and his successful investments. In addition, this also rationalizes investments better as it would help keep our emotions out and our confidence in check keeping them grounded.
The ability to look back at our past allows us to better ourselves by allowing us to learn from our mistakes and also those of others allowing us to better plan our future. But unfortunately, hindsight bias is the cost that comes along with the hindsight that we possess.
But being aware that we have this bias is the first step to bettering ourselves. This introspection allows us to improve and possibly even implement the remedies stated above potentially avoiding investment mistakes.
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
Understanding Opportunity cost and its usefulness in investing: What factors do you consider before you take any decision that involves money? These factors could include affordability, returns, usefulness, pros, and cons, etc. But have you ever considered that simply not choosing an option too has a cost associated with it?
Today we take up an aspect of economics that is generally overlooked when it comes to decision making i.e. Opportunity Cost. We also try and find out its relevance in investing.
What is Opportunity Cost?
In microeconomic theory, opportunity cost or alternative cost is the loss of potential gain from other alternatives when one particular alternative is chosen over the others.
In simpler terms, it refers to the potential benefit that a person misses out on when they choose one alternative over the other. The objective of opportunity cost is to ensure the efficient usage of scarce resources. It exists even when you make no choice at all. It also uncovers the loss of not making a decision.
Opportunity cost is generally unseen and can be easily overlooked as they are not accounted for in the financial statements. However, management or Investors use this concept regularly while making decisions that involve multiple options.
In reality, the opportunity cost theory is a very important concept. This applies not only to investors and businesses but also to individuals in their personal life.
Real-life Examples of Opportunity cost
Let us take an example that includes one of our peers. He/She has decided to pursue an MBA worth Rs. 20 Lakhs (Tuition plus boarding and dining cost) for two years. She came to this decision after receiving a government scholarship of Rs. 5 Lakh. How much cost do you think she will be paying for if she actually goes through with it?
Most of us would have already arrived at the conclusion that she will be liable to pay a cost of Rs. 15 Lac. The true cost here is 15 Lakh (as she has also earned her scholarship) plus the income he/she will have to forego by attending an MBA college. If your peer would have earned Rs. 6 Lac/year (ignoring hikes or bonuses received in this period) by working then the true cost would amount to Rs. 27 Lakh.
Many of us would ignore the opportunity cost of the peer losing out on potential income. In order to arrive at an educated decision, the peer would have to compare the cost of education plus the forgone income vs. the benefits she would receive after receiving an MBA.
We calculate the opportunity cost by comparing the returns of two options. The following formula illustrates an opportunity cost calculation.
Opportunity Cost = Return of Most Lucrative Option – Return of Chosen Option.
Take for example you are provided with the option of investing Rs. 1 Lakh. You are thinking of investing in a Blue Chip Mutual fund that provides a 10% return. You also have the option to invest in a Small Cap Fund that could provide a 20% return.
Here, by applying the formula above we would arrive at:
Opportunity Cost = 20,000- 10,000 => 10,000.
The Ratio of Opportunity Cost
We can also use the ratio of opportunity cost. This uses proportions to demonstrate the value of each choice. This is done by illustrating what has been sacrificed against what’s been gained from the alternative.
Opportunity cost = What you sacrifice by making the choice / What you gain by making the choice
Taking the same example used earlier where we invest in a Blue Chip mutual fund as Small Cap funds are risky.
The Opportunity Cost is = 20,000/10,000 => 2/1 = 2.
Opportunity Cost and Investing
Investing is all about parking money in a financial product with the hopes of making more money than what was invested. Everyday investors are faced with options where they have to decide how to invest their money in order to receive the highest or safest return. While they take the decision they usually factor in returns, the risk involved in making that decision but often leave out opportunity cost.
Opportunity Cost takes into consideration that you could miss out on a great opportunity in the future because you have committed your money to another investment. It makes it easier for us to prioritize one decision over others by putting numbers to these decisions. This results in a better data-driven method that prioritizes where our money is spent.
Opportunity cost can also be used within a company or by an individual when they decide where to raise money from. This could be through equity or through debt
The following are some of the reasons why opportunity cost helps us take better decisions apart from what has been already discussed
1. Helps us realize the cost of doing nothing.
Individuals at times are led to believe that there is no cost incurred when money is left idle. This leads them to simply keep money in a safe etc.
Opportunity cost takes into consideration the potential income the money could if invested in fixed deposits, bonds, mutual funds. This helps individuals take into account the difference their funds could make if they invest it in a financial instrument.
2. Helps take into account the cost of not disinvesting.
This often happens when an investor is too emotionally invested in a stock or has not adhered to an already set stop loss. In a situation where an investor remains locked in on a stock whose price continues to decrease he is risking not only the possibility of the stock plunging further but also the possibility of salvaging some return by investing in other safer instruments.
It is important to note that disinvestment is also an investment decision and opportunity cost helps quantify this decision by taking into consideration alternative investments.
3. Helps put into perspective the cost of not borrowing
Taking on debt is generally viewed in a negative light but this does not always have to be so. Take an example that a small company has the option to take advantage of diversifying into the new industry due to its profitability. Opportunity cost then helps the management put things into perspective if the investment can be financed and still come out profitable through debt.
Although Opportunity Cost provides the possibility of earning higher returns we should always remember that it involves looking forward into the future. This can be combated by first setting our investment objectives. Then opportunity cost could be used to help navigate the options that fit within the risk class of those objectives.
If we let our investment objectives be affected by opportunity cost then there is always going to be an investment opportunity that has the possibility of providing higher returns. The beauty of opportunity cost lies in the fact that it can be used by all. These could also be situations that are not financial.
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
A Guide to Coat Tail Investing Strategy: If you had invested Rs. 1000 in Berkshire Hathaway, in 1970 it would have grown Rs 48.6 lakh by 2014. Stunning isn’t it! How many times have you been hit with stats like this? Always leaving you wishing that you knew what Warren Buffet or your investing hero knew then.
Lucky for us there is a whole strategy based on mimicking portfolios of those whom we look up to in order to make the same gains. Today, we discuss a strategy popularly known as Coat Tail Investing which would help us mimic the investments made by our idols.
What is Coat Tail Investing?
Coattail investing refers to an investment strategy where an investor replicates the trades of well-known and historically successful investors. Smaller investors here ride the coattails of their idols in hopes of multiplying their investments. The investors that are worth replicating in this context are those who have enjoyed continuous success for a period of 20-30 years. The strategy is based on the logic that if these top investors would buy a stock for their own portfolio then it must be a great investment and hence we should buy them too.
Simple as it sounds it’s amazing that more people don’t do it. It may interest you to know that even Institutional investors tend to track several successful investors to see what they are investing in according to a report by Aite Group. In fact, even investment guru Warren Buffet admitted that much of his early success was the result of “coat-tailing” great investors like Benjamin Graham.
Thanks to regulations put in place by SEBI and media coverage individual investors like you and I are quickly informed about where these big investors are investing their money. Following are some of the means that have made this possible:
– Due to Company Disclosure requirements put in place it is mandatory for a company to disclose the names of all the shareholders holding more than a 1% stake in the company. The company reports would include the names of the major stockholders of the company.
– Mutual Funds are required to disclose their portfolios every month. This allows investors to gather information on what stocks have been bought or sold by the fund.
– Whenever there is a block or bulk deal takes place the Stock exchanges publish data of investors involved, no. of stock traded, no. of stocks that exchanged hands, and the price at which the trade took place on a daily basis on the NSE and BSE website. A bulk deal is when the total quantity of shares traded exceeds 0.5% of the equity shares of the listed company and a block deal is a trade of more than five lakh shares or a minimum amount of Rs 5 crore of a listed company.
– Media outlets, business journals, finance websites also disclose the portfolios of big investors. Of late there are even sites specifically dedicated to this purpose.
Quick Note: You can follow the investment portfolio of big investors in India using our Trade Brains Portal here.
Advantages and Disadvantages of Coat-Tail Investing?
Coat Tail Investors to date have made significant fortunes by copying the portfolio of great investors. But they also have suffered a massive loss due to this purpose. Following Advantages and Disadvantages shed some light on why this has been so
Advantages of Coat-Tail Investing
– It is easy to implement
The requirements for this strategy are to find an investor you admire, and then start copying his market moves. The heavy-duty which includes analysis and research is already done by the investors. This helps us save a lot of time and effort and at the same time reap the benefits.
– It costs us nothing
Big investors and institutional investors spend millions of dollars on creating teams specifically for identifying these stocks. The end info that they spend so much on is made available to us free of cost after they make the trade.
– Chances of Succes are high
Here investors who are already familiar with the industry or stock put in their years of expertise. Therefore following these big investors increases the odds of success.
Disadvantages of Coat-Tail Investing
– Abrupt exits may catch us off guard
Big Investors do not announce that they will be exiting the stock as this may negatively affect their gains. The news of a big investor buying or selling stock will have positive or negative effects on the share price respectively. If investors continue to hold the stock even after the big investor has sold and the price has fallen the investor may incur losses.
– Different interests
Your financial goals may not match the investors. Some investors may want to buy stock in order to make quick profits from trading, blindly copying them oud prove to be disastrous. Also, investors who want to make quick profits i.e. in the next 6-12 months may not have much to gain if they follow investors like Buffet who make investments for a lifetime. If is easy for one to confuse trading with investment picks or vice versa.
– There are too many investors already applying this strategy
Every move made by these investment gurus is constantly watched by lakhs of people. Technology has made it possible for information to be transferred in less than seconds. As mentioned earlier this now causes the prices of shares to fluctuate wildly with the smallest sign of the investors moving in or out due to market reactions. If an investor is delayed even by the shortest period of time he may end up in losses.
– Everyone makes mistakes
It is very much possible for even stock market experts to make errors. These errors, however, may result in severe consequences for those that blindly follow them. The best example, in this case, would be Warren Buffet picking IBM. He later admitted that his thesis on IBM was flawed
Closing Thoughts
After observing the disadvantages above it doesn’t take a genius to note that the stacks are piled against the common investor. Then how can one even make this strategy work?
For this, we can take notes from Mohnish Pabrai one of the most famous names in Dalal Street. Unknown to many Pabrai himself has adopted the coning approach. He is known to have joked that he’s never had an original idea in his life, but this doesn’t bother him. “ we copy the best ideas and make them our own.”
It is the latter part – ‘making them our own’ which is most important. Most of the problems that the strategy has can be eroded simply if the individual assesses and does his own research after gathering information. The investors we pick to follow are also of importance in this strategy.
Picking Buffet with the aims of making quick profits would not make any sense just like picking any other activist investor when the investor has the aims of the long term. As long as we keep ourselves updated, pick the investors whose strategies meet our aims, and do our own research after gaining trade information, Coattailing may actually lead us to personal gains.
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
Anyways, gender bias is nothing new. Throughout history, when jobs are seen as more important or are better paid, women are squeezed out. And similar to this one, there are multiple common biases that we can notice in our day to day life. But, what actually is a bias?
According to Wikipedia– “Bias is disproportionate weight in favor of or against one thing, person, or group compared with another, usually in a way considered to be unfair.”
In other words, it is an inclination or preference that influences judgment from being balanced. Biases lead to a tendency to lean in a certain direction, often to the detriment of an open mind.
Behavioral Biases in Investing:
Investors are also ordinary people and hence they are subjected to many biases that influence their investment decisions. Although it takes time to control the behavioral biases, however, knowing what are these biases and how they work — can help individuals to make rational decisions when they are susceptible to these situations.
In this post, we are going to discuss five common investing biases that every investor should know.
When a human mind is determined towards one particular behavior, it subconsciously rejects the pieces of evidence against it while confirming the ones that go in its favor. This is known as confirmation bias.
Psychologically speaking, an investor would be more inclined towards his pre-occupied information and knowledge about certain kinds of investing. While considering the pros and cons of a certain kind of investment, the buyer would most likely go with what he used to believe until now.
For example: Making an investment in Bitcoin is dangerous and pointless. If this is an investor’s pre-occupied notion then he would most likely not invest in bitcoins in future.
Gambler’s Fallacy is one such proof which states that a human mind often interprets the outcomes of a future event judging by its corresponding past events even if the two are completely independent of each other. It is inspired by the “failures of gamblers” due to their probabilistic illusions to make decisions in casino games.
Gambler’s Fallacy can be very well explained with the help of a basic example involving a coin. For future reference, let’s suppose that the coin is fair with both sides (heads & tails) having an equal probability of landing on top.
Suppose a coin is flipped 10 times and the result of each event was “Heads”. What would you bet for the next coin flip?
Now, if a human bet on the outcome of the 11th flip of the coin to be “Head” seeing the past events, then it can be considered a bias.
The above context does only imply a simple rule: The occurrence of an independent event is not dependent on past events. In this example, the 11th flip of a coin would result in both heads and tails with a 50% chance of being associated with each one of them.
The regret after purchasing a product is called a buyer’s remorse. Here, the buyers may regret that either they overpaid for the product or they didn’t actually need that product.
Nevertheless, purchasing commodities are not the only thing where people feel “buyer’s remorse”. Stock investors are also like ordinary people, and they too feel this remorse after purchasing equities.
“Was buying this stock a mistake?”
“Was my timing right?”
“Did I just buy a lemon of a stock?”
“Is the market going to collapse?”
“What if I lose money?”
In general, investors feel remorse when they make investment decisions that do not immediately produce results.
An investor’s natural instinct goes with the ones of masses, which means that he/she doesn’t seem to have a rational view on a certain investment but is more likely to deviate where the majority mass is moving — this little phenomenon is known as the “Herd Mentality”.
The term has been derived from the natural instinct of a number of sheep walking together in a herd so as to avoid falling into the pitfalls of danger.
Interestingly, you can also find a large population of investing community following herd mentality psychology in making various financial decisions like buying a new property or investing in the stock market. Seeing others getting profited with an investment, our brain tells us to go for it without a second thought.
A bidder sitting in an auction and trying to repeatedly bid on an asset often gets intimidated to continue his bidding even if it is not profitable.
As obvious, in such scenarios, the last one to bid gets the asset and hence gets the title of “the winner”. But has he actually won? What do you think? The inference can be a bit deeper than you are assessing it to be.
Such scenarios are quite noticeable everywhere, including investing.
In the stock market, every now and then, you may come across a storyline where people are buying expensive stocks because they don’t wanna lose the opportunity. Here, they are ready to bid a huge price to win that stock. However, purchasing an overvalued stock (only for the sake of winning) is most of the time disadvantageous for the investors. Another example of the winner’s curse is bidding in expensive IPOs.
Closing Thoughts
Most biases are pre-programmed in human nature and hence it might be a little difficult to notice them by the individuals. These biases can adversely affect your investment decisions and your ability to make profitable choices.
Anyways, knowing these biases can help you to avoid them causing any serious damage. Moreover, a good thing regarding these biases is that — like any habit, you can change or get over them by practice and efforts.
Hi, I am Kritesh (Tweet me here), an NSE Certified Equity Fundamental Analyst and an electrical engineer (NIT Warangal) by qualification. I have a passion for stocks and have spent my last 4+ years learning, investing and educating people about stock market investing. And so, I am delighted to share my learnings with you. #HappyInvesting
Demystifying Sunk Cost Fallacy: Have you ever been in a situation where you went to watch a movie in the theatre thinking it would be great, however, it turned out to be terrible? What did you do next? Did you walked out of the theater or continued watching it till the end because you were afraid that you have already paid for the ticket? If you choose the latter, you have fallen for the sunk cost fallacy.
In this post, we are going to discuss what exactly is a sunk cost fallacy and how it can affect your investment decisions. But first, let us understand what are sunk costs.
What are sunk costs?
Sunk costs are those irrevocable costs that have already been occurred and cannot be retrieved. Here, the costs can be in terms of your money, time, or any other resource.
For example- Let’s suppose that you bought a brand new machine. However, after using it for three months, you realize that the machine is not actually working as you desired. And obviously, the return period of the machine has surpassed. Here, even if you sell the machine, you will get a depreciated value compared to what you originally bought. This cost is called the sunk cost.
In general, people should not consider sunk costs while making their decisions as these costs are independent of any happenings in the future. However, humans are emotional beings and unlike robots, we do not always make rational decisions.
Examples of Sunk Cost Fallacy
Sunk cost fallacy, also known as Concorde fallacy, is an emotional situation where the individuals take sunk costs into consideration while making the decisions.
We have already discussed the example of watching the entire movie (even if it is terrible) just because you, as a consumer, won’t get back the money for your ticket. This is a classic example of the sunk cost fallacy.
Another example can be when you eat foods that you do not like because you have already bought that food and cannot revoke that sunk cost. Similarly, overeating after ordering foods in restaurants because food has been already ordered is also an example of sunk cost fallacy.
Further, a typical example of the same fallacy is when you keep attending the miserable classes of your college (that you do not enjoy) because you have already invested a lot of time in that course and also have paid the tuition fee. Besides, salaries, loan payments, etc are also considered as sunk costs as you cannot prevent these costs.
A quick point to mention here is that not all past costs are sunk costs. For example, let’s suppose you bought a shoe and you didn’t like it after reaching home. However, as the shoe is still in the return period of 30 days, here, you can return the shoe and get back your purchase price. This is not a case of ‘sunk cost’.
Sunk Cost Dilemma
Sunk cost dilemma is an emotional difficulty to decide whether to continue with the project/deal where you have already spend a lot of money and time (i.e. sunk cost) or to quit because the desired result has not been achieved or because the project has an obscure future.
Here, the dilemma is that the person cannot easily walk away from the project as he has already spent a lot of time and energy. On the other hand, continuously pouring more money, time, and resources into the project also does not seem a good idea because the outcomes are uncertain. This dilemma of deciding whether to proceed further or to quit is called the sunk cost dilemma.
For example- Let’s say you started a business and invested $200,000 over the last three years. However, you haven’t achieved any wanted results so far. Moreover, you cannot see the business working out in the future. Here, the dilemma is ‘what to do next?’. Should you bear the losses and move on, or should you invest more resources in that uncertain business?
Another common example of a sunk cost dilemma can be a bad marriage. Here, the couples find it difficult to decide whether to save themselves (and their spouse) by splitting up when they are sure that things are not going to work out. Or should they hold on to the marriage just because they have already spend a lot of time together and breaking up will make them look bad?
Sunk cost dilemma in Investing
Even investors are common people and they face the sunk cost dilemma while making their investment decisions.
For example, let’s say that an investor bought a stock at Rs 100. Later, the price of that stock starts declining. In order to minimize the losses, the investor averages out the purchase price by buying more stocks when the price kept falling (also known as Rupee cost averaging). Here, the dilemma happens when the stock keeps underperforming for a stretched period of time. Here, the investors are uncertain whether they should book the loss by selling their stocks, or should they continue averaging out with the hope that they may recover the losses in the future.
Another example of the sunk cost dilemma is people buying/selling aggressively in risky stocks once they have incurred a few major losses in the past to ‘break-even’ those losses. However, the losses have already been incurred, and investing in risky stocks to cover those losses won’t do any good to such investors.
The better approach would be to choose those stocks that can give the best possible returns in the future, not the imaginary aggressive returns that they expect to match up the sunk cost. As an intelligent investor, people should ‘not’ consider the sunk costs while making their decision. However, this is rarely the case.
It is no denying the fact that nobody likes losing and hence the past losses can influence the future decisions made by the individuals. However, one must not consider sunk costs while making their investment decisions.
As sunk costs cannot be changed (recovered), a rational person should ignore them while making their judgments. Here, if you want to proceed, first you should logically assess whether the project/deal is profitable for the future. If not, then discontinue the project. In other words, try to forecast the future and react accordingly.
Anyways, a few methods of solving the sunk cost dilemma is by opting for incremental wins over the big ones, increasing your options (not just to completely quit or go all-in), and in the terminal case, cutting your losses. When stuck in this dilemma, try to make minimum losses by looking at the mitigating options.
Hi, I am Kritesh (Tweet me here), an NSE Certified Equity Fundamental Analyst and an electrical engineer (NIT Warangal) by qualification. I have a passion for stocks and have spent my last 4+ years learning, investing and educating people about stock market investing. And so, I am delighted to share my learnings with you. #HappyInvesting
Understanding what are Black Swan Events in Stock Market: European explorers would have been more than taken aback when they first encountered the first black swan in the 17th century during their conquest in Australia. After all, if you’re habituated on seeing white swans all your life and suddenly a swan of black colour appears, you might also be astonished.
Anyways, this concept of seeing something rare and totally different is not only limited to swans or birds. The black swan we are discussing today in the world of investing holds the similar astonishing features of a real black swan. In this article, we’ll discuss what are black swan events in the stock market, examples of a few past black swan events and how can you handle black swan events while investing. Let’s get started.
What are Black Swan Events?
A Black Swan in finance is an unpredictable event that is beyond what is normally expected of a situation and has potentially severe consequences. This theory is basically a metaphor that describes an event that comes as a surprise, but can have a major effect.
The theory was put forward by former Wall Street trader, Nassim Nicholas Taleb in 2001 which was later popularized through his book ‘Black Swan’, which came out a year before the crash of 2009. The theory illustrates the limitations of learning from our observations and experience just as when a black swan was discovered in Australia.
One may have seen millions of white swans throughout his life but it would take only one black swan to shatter his belief that all swans are white. Today we take a closer look in order to understand black swans in the finance world and how we can prepare for them.
What makes an event a Black Swan?
There are no limitations to ways in which a Black Swan event can manifest itself. The causes of black swan may be a natural disaster, wars, or even an outbreak of a virus. These events do not always have to have sudden consequences but instead can be slow like the fall of the Roman Empire. Taleb identifies three common characteristics between all Black Swans
They are so rare that the possibility that they might occur is unknown.
They have a catastrophic impact
When it does occur and when it is explained in hindsight the event actually seems predictable.
The effects of black swan events are magnified and tend to be catastrophic primarily because they confound our expectations that a universe is an orderly place.
A Few Different Black Swan Events in Stock Market in Past
The stock market has experienced multiple black swan events in the past. Here are some of the most infamous Black Swans in the recent past.
1. Harshad Mehta Scam
The Harshad Mehta Scam, when exposed, had staggering effects on the Indian economy that had just opened up to the world. The scam amounted to Rs. 4025 crores which today would amount to Rs. 24000 crores. The scam resulted in the BSE Sensex falling by almost 45%. It took almost 18 months to recover post this. You can read more about Harshad Mehta Scam here!
2. 2008 Recession
This recession was one of the biggest since the great depression. It is estimated that over $10 trillion was wiped out in the global equity markets. The financial crisis of 2008 is one of the most recent Black Swan events, caused due to the US mortgage and credit crisis. It also caused the largest bankruptcy in Lehman Brothers. In hindsight, many rightly say that it was bound to happen and a few outliers even predicted it.
3. The 9/11 Attacks
The Attacks on the twin towers of New York World Trade Centre too is a Black Swan. The attacks led to the closure of the NYSE and NASDAQ. Estimates state that up to 1.4 trillion was lost within a week. The airline industry was the worst impacted due to the attack.
Quick Note: The event of Crude Oil Prices diving into negative in April 2020 that broke into the news for its extraordinarily inconceivable negative price dump, was also an example of Black Swan events. You can read more about this event here.
Is the COVID-19 Pandemic a Black Swan Event?
The pandemic has been argued to be a black swan event by many sources. But the classification would also depend on the region.
For a country like China, the virus is most definitely a black swan as they were caught by surprise when the virus first broke out in December. Other countries like India, however, could have seen it coming as they were adversely affected only months later.
In an interview with Bloomberg last weekNassim Nicholas Taleb said, “It was not a black swan. It was a white swan. I’m so irritated people would say it is a black swan,” while referring to coronavirus. “There is no excuse for companies and corporations not to be prepared for that. And there’s definitely no excuse for governments not to be prepared for something like this,” Taleb added.
How can Investors handle a black swan event?
We regularly come across predictions given by the so-called finance gurus on television etc. The very first step would be to ignore these so-called predictions and forecasts. Taleb criticizes prediction that may even extend up to 30 years bu what we don’t realize is that we cannot even predict the next summer because our cumulative prediction errors for political and economical events are so monstrous.
– Steps Prior to the Black Swant Event
1. Diversifying Investments
Regardless of whether the market is undergoing a bull or bear run, it is best to also follow the basics of investing and diversify. Investors who only invest in equities face tremendous value damage. But instead, if his investments are spread across equities, liquid assets, and gold then the damages will be lower. This will help an investor survive the Black Swan.
However, there are investors who strive during a black swan. It is also important to note that if a person invests solely with the fear that a black swan event may occur at any given moment his returns would severely be impacted. What we could do is hedge our portfolios by means of diversification so that they perform in a bullish run and reduce losses when a black swan hits. For this investors have a look for assets that are likely to underperform during the bull run but provide returns when the market crashes and then include them in your portfolio.
One example would be the Universa Investments fund run by Taleb and Mark Spitznagel. This fund has benefitted hugely during the coronavirus. Its returns for 10 years prior to the pandemic were low or loss-making. During the pandemic, however, the fund had risen by 3600%. Despite the losses made the fund is still up 200%. One report also shows that if an investor had only invested 3.3% of his portfolio in the Universa fund and the remaining in the S&P500 tracker fund, the investor would still see returns of 0.4% in March despite the benchmark index falling 12%.
– Steps to take during a black swan event
2. Staggering Investments
While investing during an ongoing black swan event it is best that the investors stagger their investments over a period of time instead of investing lump sums in one go. This is because the duration of a black swan event is difficult to predict. Staggered investments will provide investors the opportunity to take advantage of falling prices during bearish trends.
3. Take Shelter in Safer Investment Options like Gold
Gold is considered a safe-haven when a black hawk event occurs. It is best to diversify investments beforehand into gold. During the Arab oil embargo between 1971 and 1979, when the world was rocked, the prices of gold skyrocketed 2400%. The increase in gold prices during black swan events has repeated time and again for eg. 9/11, the 2008 crisis, and again during COVID-19.
4. Only look for companies that are already financially sound instead of ideas
Prior to black swans when the market is doing good even companies with weak financials but great innovative ideas are able to raise funds and strive. But after a crash, these companies find it hard to even survive. Hence during a black swan, it is best to invest in financially sound companies that are cash-rich, have good ROCE, low debt, and good management.
Closing Thoughts
Black Swans are generally considered to result in negative connotations but the result generally depends on the perspective of the individual. Take the example of John Paulson during the 2008 crisis or George Soros in 1992.
Predicting a black swan can be next to impossible as there are just too many events that can happen at any given time and their prediction in the past took a lot of skill and luck. However, what we can control is making our portfolios as Black Swan Proof as possible.
That’s all for this article on Black Swan Events in stock market. I hope it was useful to you. If you have any queries related to black swan events, feel free to comment below. I’ll be happy to help. Take care and happy investing!
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
After the gold prices crossed Rs. 50,000 for 10g after 9 years period since 2011 in India, there seems to be no stop to how high the prices can go. The gold prices touched Rs.58,100 for 10g in Bangalore as of 7th August. This shouldn’t have come as a surprise because commodities like gold have always had exceeding demand in India. Especially after considering that India is one of the world’s largest consumer second only to China.
However, the increase seems unrealistic in times of pandemic where every investment seems to have suffered, only gold seems to have found its biggest boom. In the three year period from September 2016 to October 2019, gold saw an increase of 25% in its value. But along with the increasing troubles of 2020 in the midst of a pandemic the value of gold has already shot up 37.8% or by Rs. 15,240 with 5 more months to go.
Today, we take a look at the scenario finding possible reasons for the boom and also discuss if investing now is a good idea.
The Indian Gold Market
It would be rare to find a market in India that has consistently been in demand such as that of Indian Gold. There have been many jokes that have passed on claiming that the gold available in households is more than sufficient to cover all the deficits and debt that our country faces. But when we look at the following figures these statements may not be exaggerated. Indian households have piled up as much as 25000 tonnes of gold. To put things in perspective that alone would amount to Rs. 145.25 lakh crores in today’s rates. India’s central bank the RBI, on the other hand, has a total holding of 653.01 tonnes of gold. That too after buying additional 40.45 tonnes of gold in the current year.
For many Indians, gold has always been the favorite investment instrument traditionally apart from the land. Despite this, a significant portion is still placed in liquid assets like cash, stocks, etc. In the times of a pandemic, individuals are seeking shelter for their savings in an investment that doesn’t necessarily provide great returns but at least maintains its value and provides liquidity. This has led to the demand for gold skyrocketing to new heights.
Now we take a look at some other factors that have lead to this increase in demand.
1. Scarcity
As you may already know that gold is scarce because all gold is mined. Over time however mining for more gold has become difficult and due to its characteristics, it is safe to say most of the gold is recycled and put back into circulation. But luckily enough this gold cannot be consumed like other commodities. Enabling it to keep its value since time immemorial keeping up with the rising population. Another factor that adds to its scarcity due to its lack of consumption is what happens after the commodity is bought.
Gold, after it is bought, is taken out of the market for long periods of time only to be kept in a drawer or bank locker taking it out of the market for years. But these factors like scarcity, inability to consume, etc, have always existed. Then why have the prices increased now?
These factors have always existed at lower prices only because the increasing demand has always been checked with adequate supply. In order to limit the spread of the virus most countries had to resort to a lockdown. This has had adverse effects on not only mining but also a lack of shipments. As per some estimates, the global demand for gold is 1000 tonnes more than the supply. This rise in demand as mentioned earlier has been due to people’s search for a secure asset.
2. Culture
The demand for gold also has its roots in humans’ desire for beauty. Demand for gold in India is interwoven with culture, tradition. This is primarily because of the dependence of marriages and other functions on gold. According to a study by the World Gold Council, Indian consumers view gold as both an investment and an adornment. When asked why they bought gold, almost 77 percent of respondents cited the safety of investment as a factor, while just over half cited adornment as a rationale behind their purchase of gold.
3. Geopolitical Factors.
People search for a safe haven like gold extends to periods of geopolitical tension like war. This is the reason why crisis situations like wars have a negative impact on almost all asset classes. But when it comes to gold it has a positive impact. This increase in the price of gold was earlier also noticed during the Korean nuclear crisis. Similar trends are noticed due to tensions between India-China and US-China.
4. Exchange Rates
It has been observed that a weakened US Dollar also leads to a rise in gold rates. The same is noticed in the current situation.
5. Limited Influence by Big Market Movers.
In stock markets, it is the FII and DII’s that are termed as market movers. This is because of their ability to influence market trends due to top huge capital in possession. In the Gold market, it is the central banks that have a significant influence. This is because almost every central bank keeps reserves in the form of investment in gold. When an economy is performing well and the RBI has sufficient foreign reserves it will want to get rid of gold.
Because gold does not generate any return and a booming market will provide a better return if the money is invested elsewhere. But in this scenario, the other investors as well will not want to invest in gold as they too would prefer to earn returns. Hence central banks are caught on the wrong side of the trade leading to a fall in the value of gold.
But however, the influence the central banks like RBI have is limited. This is because of the Washington Agreement. This agreement, however, is not binding and is more like a gentleman’s agreement. According to it, central banks will not sell more than 400 metric tons a year. Limiting the influence of central banks even if they want to benefit from high prices.
In Closing: Should you Invest in Gold now?
Predicting Investments is always tricky due to the uncertainties present. Most of us may have already noted the effects of economic turmoil on gold and decided to invest in the future if we are faced with a similar scenario. But that doesn’t help today, does it? In order to help you take better decisions, let us take a look at previous gold rate highs.
If you notice in the above chart you’ll be able to see that the Gold rates boomed in the 1980s as well. But a person investing in such a high would only reap the benefits almost 3 decades later post 2008. Similarly, a person who invested in 2011 is reaping some minimal positive benefits in 2020. Hence considering this if investments were made in gold say in early 2020 is a completely different story than investing now.
However, it is also best to take a look at the forecasts predicted by analysts. Analysts, however, have been bullish and have predicted that gold prices could go up to Rs. 65,000 for 10g in the next 18-24 months. But it is necessary to note that these estimates depend on a period that COVID-19 will take a while more to be controlled. Also, public vaccine availability is not anticipated for at least months to come.
From the above arguments, it shows that when the investment is made on a long term perspective there may be other alternatives that provide better results in the same time frame. However, investing for short periods completely depends on one’s estimates for COVID control or vaccine availability oy unavailability.
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
Understand Pump and Dump scam in Share market: Starting from the Nigerian Prince in exile asking for money, us winning lotteries we never took part in, and a distant relative we never heard of trying to send us his inheritance, has bought us to a stage where we are waiting to find out how much more ridiculous these scams can get. Similarly, the stock market world with all its rules, regulations, and watchdogs is not free from scams. Today we have a look at one such method used to scam naive investors of their money called the Pump and Dump.
What’s the Pump and Dump?
In the Pump and Dump scheme, the promoter or large investors mislead the market into believing that a particular stock is valuable. They release false information which in turn gives rise to the first portion of the scheme known as ‘A Pump’. The con investors at this stage buy large portions of the valuable at cheap prices. Here due to the credibility held by the promoter or the large investor the market too begins investing in the stock.
This leads to a rise in the demand which causes the stock to be inflated with increased prices. Once the price increases the promoters begin the second phase ‘ The Dump’. Here the promoters and investors sell their stake at the higher prices making a profit. This causes a market reaction where the price falls and the naive investors who believed then news are left suffering the losses.
Furthermore, after the dump stage, the naive retail investors hold on to the stock thinking that the fall in prices is a small market corrected and still anticipate the prices to rebound. But to their misery, the stock prices keep falling to their original value making it too late for the naive retail investor to exit without losses.
At times brokerage firms and other organizations also make use of the pump and dump. Here they are either hired by the promoters or they themselves purchase a stake in the company they wish to use in their scam. Once the shares are acquired the brokerage firms then begin spreading misleading statements that attract investment in the company which leads to increased prices. At this point, they dump the stock.
— Stocks used in Pump and Dump Scams
Generally, large investors or brokerage firms target penny stocks. This is because they have low values and are easy to inflate. Large-cap stock too are at times prey to this, but even a large investor with the ability to influence a Large-cap is rare. Pump and Dump also make use of the psychological Fear Of Missing Out (FOMO). Everyone regrets not being able to invest in big multi-bagger stocks like Apple, Google and Facebook etc during their initial stages. Hence, the search for similar stocks leads retail investors to fall victim to such Pump and Dump schemes.
— Channels/Mediums used in these schemes
Pumping and dumping were traditionally done through cold calling. Here the brokers would cold call innocent investors and pressurize them into buying these stocks. They would also use strategies where they would leave a message on the answering machine with misleading information regarding the stock. This made it look like it was missed call with the information not intended for the receiver. This scheme then moved onto emails and currently even makes use of social media.
Infamous Pumpers and Dumpers
(From Left to Right: Harshad Mehta, Ketan Parekh, Jonathan Lebed, and Jordan Belfort)
1. Harshad Mehta Scam
The pumping followed by Harshad Mehta in the 1990s caused the great bull run. This earned him the nickname the Big Bull. Harshad Mehta also had tricked banks to fund the bull run. He caused the stocks of ACC by 45 times. The markets crashed the day he sold. Harshad Mehta was arrested over numerous charges ( 70 Criminal Cases and 600 Civil Action Suits).
Ketan Parekh a Chartered Accountant earlier worked with Harshad Mehta. Parekh made use of circular trading to pump and dump. He would have one of his companies buy a stock and have it sold to another company that he owned. He would do this involving many of his companies. This increased the trading volume of the stock which in turn attracted investors. This caused an increase in the prices and at this stage, Ketan Parekh would dump. Ketan Parekh was arrested in 2001.
3. Jonathan Lebed Scam
In 2000, Jonathan Lebed was only 15 years old when he successfully Pumped and Dumped. He would purchase penny stocks and then promote them at the message board. Once the prices increased he would sell them at a profit. He was caught by the SEC and a civil suit for security manipulation was charged against him. Lebed made $272,826 in profits. He settled his charges through these earnings.
4. Straton Oaks Scam
This may be perhaps one of the most famous pumps and dumps among millennials thanks to the movie Wolf of Wall Street. The movie is adapted from the memoir of Jordan Belfort. His brokerage firm Straton Oaks would inflate the prices of the stocks he owned through misleading statements and later sell them at profit.
Stocks that were Pumped and Dumped in Past
1. Surana Solar Ltd
In the case of Surana Solar Ltd, the shares rallied over 725% after new broke into the market that India’s most successful investor Rakesh Jhunhunwala had purchased a stake in the company. Everyone wanted a piece in the company that Jhunjhunwala believed in. It was later clarified that another investor had used conned the market by investing in the company using the ‘Rakesh Jhunjhunwala’ name. Once this news broke out the shares fell causing huge losses to naive retail investors.
2. Sawaca Business
The case of Sawaca Business Machines Ltd is special because the pump and dump scheme here was not used once but twice. In the price graph movement above we can see a rally from 2011-13 and again from 2014-15. The shares rallied over 2500% reaching heights of Rs 225.50 per share from 2011-13 and then fell again to their original figures. After the fall the shares rallied again from 2013-15 touching prices od Rs 204 and giving gains of over 1000%. As of 10th June 2020, the shares are valued at Rs 0.53 per share. A con investor who would have even invested Rs 10000 would see his wealth scale over 25 lakhs if pumped and dumped at the right time during the two periods. However, the loss to retail investors has been incomputable.
How to protect yourself from Pump and Dump?
1. Tenurity of stock being traded on the exchange
Generally, stocks that are used by scamsters for pumping and dumping will have been made available for less than a year. These stocks are generally penny stocks. Companies that are considered small-cap do not have considerable information made available to the investors to make informed decisions. Investors fall victim to their emotions and the pressure selling by brokers in these cases.
2. Look at the long term Stock Patterns
Generally in cases of Pump and Dump it is possible for investors to notice similar patterns during the pumping stage. After the stocks are influenced and are in the pumping stage an investor will be able to notice a steady increase every day in the penny stock. This sudden increase in price would be bizarre when coupled with the previous low trading volumes.
3. Shade of Influence
If a broker pressurizes you to purchase a penny stock there is a good possibility that it is a scam. Great stocks sell themselves and do not rely on large investors or broker pressure. Irrespective of the medium, be it emails/social media/brokers, such schemes generally violate the basic rule of high return high risk. The proposal generally promises high returns with no or low risk. There may also be claims of insider information available to influence the proposal to buy the stock. Investors must be aware of such red flags.
Conclusion
Scammers have adapted to the changing times but for an honest investor, the requirement to remain safe remains the same. If an investor does his own research and homework as long as he stays away from so-called tips and recommendations the possibility of him being fooled remains non-existent.
That’s all for this post on Pump and dump scam in stock market. I hope you have found this post useful and will try to stay away from these cheap scams in stock market. Take care and happy investing!
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
An overview of Trading Psychology to understand what goes inside the mind of a trader: Trading psychology is the most important aspect of trading even more important than the technical and fundamental aspects of making trades. To be able to control one’s emotion, to be able to think fast on one’s feet and being disciplined, are some of the very key features of this trading psychology that every trader needs to learn eventually.
“I don’t want to be at the mercy of my emotions. I want to use them, to enjoy them, and to dominate them.” ― Oscar Wilde
Taking quick decisions, avoiding panicking, and sticking to one’s informed resolution in times of crisis is what sets a good trader apart from an average one or should I say, the winning one from the losing ones.
Biggest Psychological Tension While Trading
Not maximizing and holding on to a trade for too long, are two sides of the same coin. When I am saying, not maximizing, all I am saying is that when a trade goes in favor, we tend to book our profits too quickly and not maximize the potential. And this is critical because, with the technical and fundamental view remaining the same, there is no reason to book just because something is making money. We should try and squeeze the maximum possible juice out of fruit i.e., the trade.
Similarly holding on too long on to a position and not booking substantial margins even though the market is showing a change in momentum, is another psychological issue with trading. We are always of the viewpoint, what if I book too early. But one should understand that “Profit in hand, is better than profit in books”.
Staying flexible and being open to opportunities around to better the trade price or hedging is an important psychological aspect of trading. As the saying goes in the market, “Bulls Make Money, Bears Make Money, Pigs Get Slaughtered.”
Trading Psychology – Few Important Points to Know
— Avoid Over-Analysis Paralysis
This is the most common psychological trait associated with trading. We tend to over-analyze and over research the trades, before executing them. And which sometimes leads to trade been missed or we don’t take that trade, because some of our technical or fundamental parameters didn’t signal the trade. Too much information sometimes overcomplicates trading.
— The Randomness of Market
We have to accept the fact that markets are random to a large extent. This statement might come as a surprise to many. But we have to understand that our technical and fundamental analysis only works to an extent in the market. And if markets were not random, the technical and fundamental parameters working so far should always be able to predict the market future.
But, that’s never the case. So as long as we are in sync, with the randomness in the market, we should maximize the possibility. Because sooner or later, the randomness will take over and we have to change the parameters.
— Knowing When to Exit
This skill is as important, as the art of knowing when to enter. Having a firm plan of when to exit is an important ability that every trader should develop. Having the mastery of this skill goes a long way in making the most of the profitable trades and exiting the wrong trades with minimum damage.
The best way to go about this strategy is to exit a part of your position when it makes to a decent profit. Doing this, locks in some profit and it also gives an opportunity to enter again if the markets correct again. And most importantly it gives confidence about one’s trading skills.
— Accepting when you are wrong
To accept when one is wrong is the most difficult art in humans. Similarly, in trading too, if we are able to accept that we have gone wrong in taking a trade, it goes a long way in prolonging one’s trading career. Its a proven fact, accepting a wrong trade, avoids the chain of wrong trades and which goes a long way in preserving one’s trading account.
There are many fraudsters in the market who simply circulate a message (via SMS/email/any other social medium) spreading positive/negative rumors depending on whether they want to sell or buy. One should completely avoid falling for this honey trap, as people might lose a large chunk of their capital by trading this penny or rumor based tips. Traders should always use their informed judgment before entering any potions in the market.
— Have a Winning Attitude
This is an acquired trait over time. The winning attitude develops over time. What we need to understand here is that no trader has a 100% success rate with their trades. It’s our attitude, to do our background research (could be technical or fundamental) on each and every position/trade we take, makes a difference. Lack of discipline while trading, leads to disaster. The positivity with which we enter a trade makes a world of difference in the outcome of the trade.
— No Revenge against the Universe
The Universe here is the universe of trading. An individual trader is like grain of sand on a beach. He/she is simply not big enough to take revenge from the market. Therefore, we should never get into the mentality of taking revenge against the market. One always needs to remember, we are a part of the market and we cannot trade without the market. Moreover, it would not make any difference to the market, if a small trader like you or me is not there in it.
Closing Thoughts
“Every trader has strengths and weakness. Some are good holders of winners, but may hold their losers a little too long. Others may cut their winners a little short, but are quick to take their losses. As long as you stick to your own style, you get the good and bad in your own approach.” – Michael Marcus
Trading psychology is the most important aspect of trading that every trader needs to learn. In conclusion, we can say that the whole psychological warfare of trading, is the sole pillar on which the world of trading runs. Mastery of one emotional quotient goes a long way in having a long and rewarding trading career.
Hitesh Singhi is an active derivative trader with over +10 years of experience of trading in Futures and Options in Indian Equity market and International energy products like Brent Crude, WTI Crude, RBOB, Gasoline etc. He has traded on BSE, NSE, ICE Exchange & NYMEX Exchange. By qualification, Hitesh has a graduate degree in Business Management and an MBA in Finance. Connect with Hitesh over Twitter here!
Understanding corporate Spin-Offs and how they work: There are many corporate actions that act as a catalyst in the market and results in the prices of a share changing drastically within a short frame of time. A few common examples of such catalysts are mergers, acquisitions, bonus shares, buybacks, etc. The announcement of all these events results in rapidly increasing (and sometimes decreasing) of share prices in a short period. Therefore, share market investors and participants need to know what exactly these catalysts mean. One other typical example of such events are corporate spin-offs.
In this post, we are going to understand what are corporate spin-offs, how they work, their advantages, disadvantages and why does a company opt for spin-off. Let’s get started.
What are Corporate Spin-Offs?
A corporate spinoff is an operational strategy where an existing division of the parent company is dissolved and a new company is created in place of the division which is now independent of the parent company. Ownership in the newly formed independent company is given to the shareholders of the parent company on pro-rata based on the holdings in the parent company.
The new company resulting from this corporate action is known as the company spun-off. The company spun-off acquires its assets, employees, and other resources from the parent company.
A spin-off is a mandatory corporate action. In a mandatory corporate action, the board takes the decision and the shareholders are not permitted to vote.
To make the topic more comprehensible we shall be referring to the division of the company that is spun off and becomes independent as ‘Spinoff Ltd’. The portion of the company that remains with the existing company earlier will be referred to as ‘Parent Ltd’. The shares of the newly created Spinoff Ltd are distributed to the existing shareholders of Parent Ltd in the form of a stock dividend.
Why does a company opt for Spin-off?
There are a number of reasons why a company may opt for a spin-off. Here are the top grounds why a company may go for a spin-off:
1. Benefits of Focus
Companies that go for a spinoff generally have divisions that are least synergetic and have distinct core competencies from that of the Parent Ltd They find turning these divisions into independent companies i.e. into Spinoff Ltd would be most appropriate.
A spin-off would enable both the Parent Ltd and the Spinoff Ltd to sharpen focus on its resources and manage themselves better off independently.
Spinoff Ltd benefits from the spin-off the most because they get a new management that is focussed only on the goals of Spinoff Ltd. The newly assigned leaders present here would be experts in the field with focus only on the goals of the Spinoff Ltd. This would also help Spinoff Ltd override corporate bureaucracy that was impeding its growth in Parent Ltd.
2. Due to Failure to sell a division
At times Parent Ltd might have decided to sell off one of its divisions but does so unsuccessfully. In such cases, the company uses spin-off as a last resort to separate itself from the division.
3. Reduced agency costs
At times the parent company may enter sectors that are soo diverse from its core competencies that its investors may show no interest in the new division or may even oppose the new division. In these cases, the company incurs agency costs while resolving disagreements between the management and the shareholders.
If the new division is the cause of disagreement a spin-off will prove beneficial to Parent Ltd.
This will also result in satisfied shareholders.
4. Risk, Profitability, and Debt
If a division of a company increases its overall risk due to the sector it operates in the board may take a decision to spin-off that division.
A division may also have all the characteristics of growth in the future but its current performance or losses may be affecting the parent company. In such a situation the division may be spun off.
When a Spinoff Ltd is created it may take on the debt of the Parent Ltd. Or at times Parent Ltd. may give Spinoff Ltd a fresh start by not transferring any debt. This will depend on the strategic perspective of the board.
5. Reduced Overheads
Parent Ltd will benefit from the reduced overheads that pertain to the division which now becomes Spinoff Ltd. On the other hand, Spinoff Ltd will enjoy the freedom of taking care of its own overheads as required without any interference.
Although there are a number of reasons why a company may opt for a spin-off it is basically due to the fact that it feels that by doing so it would turn out to be beneficial to both Parent Ltd and Spinoff Ltd if they operated independently.
What is the Spin-off Process?
A spin-off may take anywhere from half a year up to over 2 years or even more to be executed. Once the board takes the decision there are multiple steps that follow. They include identifying well-suited leaders for Spinoff Ltd. Creating an operating model and financial plans to suit the business of Spinoff Ltd.
This is because the parent company is still responsible for its division. Proper communication about the terms of the spin-off to the shareholders is also necessary. This is followed by completing the legal requirements. The parent company also focuses and helps Spinoff Ltd to create a new distinct identity before the spin-off.
Types of Corporate Spin-offs
Here we classify spinoff on the basis of the ownership retained by the parent company.
– No ownership retained
In what is called a pure spin-off the parent company does not retain any ownership in Spinoff Ltd. 100% of the ownership in Spinoff Ltd is distributed among the existing shareholders of the company. Here Spinoff Ltd gets greater autonomy in its operations once the spin-off is complete.
– Minority Ownership Retained
Parent Ltd is also allowed to hold up to 20% of Spinoff Ltd. In such a case say if 20% is retained by Parent Ltd, the remaining 80% is distributed among the shareholders on a pro-rata basis. Here the parent company enjoys a greater focus on is operations and still retains some influence and decision making ability in the company spun-off.
There is also a possibility of a partial spin-off where the company may only spin-off a part of its division and retain minority or not retain ownership accordingly.
Effects of spin-off on price of securities of the company involved
Once a spin-off takes place the share prices of Parent Ltd will fall. This is because a spin-off involves the transfer of assets from Parent Ltd to Spinoff Ltd. This will result in reduced book value of Parent Ltd and hence its reduced price. However, the reduction in price is set-off by the share price of Spinoff Ltd. This is because Spinoff Ltd will receive the same assets transferred from Parent Ltd. Hence the investor will not face any immediate loss of value.
For eg. say the market cap of the company before the spin-off stands at Rs.10 crores and its current share price is Rs.100. Say the assets that will be transferred to Spinoff Ltd are worth Rs.2 crores. After the spin-off, the market cap of Parent Ltd will be worth 8 crores resulting in a post spinoff share price of Rs.80. The share price of Spinoff Ltd would be Rs.20 with a current market cap of Rs.2 crores.
Reduced demand from Funds
These prices will remain temporarily as the shares will be subject to market volatility. Spin-offs are said to cause sell-offs, particularly in the index-based funds. This is because an index shows the topmost companies in a market based on their market cap. The companies undergoing spin-off may no longer suit the requirements of the market index.
Parent Ltd too may lose its position among the top stocks due to the reduced market cap after the spin-off. This will cause funds that follow the indexes to sell the shares of Parent Ltd as well. Other funds may too sell the shares of Spinoff Ltd. This is because Spinoff Ltd may not suit their capital requirements, dividend requirements, etc. This will result in a reduced demand and fall in the price.
The cost of the spin-off will have to be borne by Parent Ltd. They will include legal duties and other costs of set-up.
2. Employee’s Discomfort
The employees in the division being spun may have joined the Parent Ltd owing to its reputation. They may be put in a situation where they will lose that identity and at the same time be confronted by the uncertainty of Spinoff Ltd.
Spin-offs as part of an Investing Strategy
The share price of Parent Ltd gets reduced after the spin-off. But this is made up for by the shares of Spinoff Ltd that the existing shareholders receive as a stock dividend. As discussed earlier due to market reactions the price may further fall.
After a spin-off takes place investors have the option to either hold onto both the shares of Parent Ltd and the shares of Spinoff Ltd. Or they have the option to sell both or either one. But before deciding which is better let us have a look at what historical studies have shown us about a spin-off.
— Parent company shares
According to a study by Patrick Cusatis, James Miles, and J. Randall Woolridge published in 1993 issue of The Journal of Financial Economics, it was observed that the parent companies beat the S&P 500 Index by 18% during the first 3 years. A study by JPMorgan showed the parent companies beating the market returns by 5% during the first 18 months.
A more recent study by the Lehman Brothers investigated by Chip Dickson between 2000 and 2005 showed that parent companies beat the market average by 40% during the first two years. Due to their strong market cap, holding onto shares of Parent Ltd will be well suited for those investors that look for stable and low-risk returns. This is because as we will observe ahead, the returns from Spinoff Ltd are higher in comparison. But the shares of Parent Ltd are observed to perform even in times of market downturn.
— Shares of the company spun off
According to the same study published in the 1993 issue of The Journal of Financial Economics, it was observed that the companies spun-off beat the S&P 500 Index by 30% during the first 3 years. The study by JPMorgan showed the companies spun-off beating the market returns by 20% during the first 18 months. The study by Lehman Brothers, investigated by Chip Dickson between 2000 and 2005 showed that parent companies beat the market average by 45% during the first two years.
All the studies show that the shares of Spinoff Ltd would not only beat the market but also would perform better than the shares of the Parent Ltd. It, however, should be noted that the share price of the spun-off companies is highly subjective to market volatility. They outperform in strong markets and underperform in weak markets. Hence they are much more suited for individuals with risk appetite.
Investors should also note that it is not the case that all spin-offs are successful. There have been situations where spinoffs have performed negatively. The best way to assess future performance is for the investor to find out why the company is attempting to have the division undergo spin-off. This is to assess if the company is using the corporate action to simply get rid of its debt or if the company is getting rid of a division in which they do not see much future prospect. In such situations, a study of debts and losses pertaining to the division in the companies books will help.
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
An overview of Coffee Can Investing Approach: A middle class Indian would spend most of his youth being forced into education, his early adulthood building a career, and taking care of his parents. He would be hit by a midlife crisis before 50. His late adulthood would be spent preparing for retirement i.e. if he hasn’t started already and ultimately banks on his kids to take care of him. As young adults, the kids now take up the responsibility with pride as is demanded by the Indian tradition and culture.
A squirrel life, on the other hand, lives chiefly on trees as they forage for food and escape predators. One thing that is interesting about squirrels is that they too try and stock up on nuts for the future. Unfortunately for the squirrels and fortunately for us, millions of trees are accidentally planted by squirrels who bury nuts and then forget where they hid them. Because of a squirrels life spanning only 11-12 months, they do not generally get to reap the benefits of an oak they planted, as oaks take up to 30 years to grow. But they still live in forests that may well have been accidentally planted by squirrel fathers decades ago.
What does it take to retire?
Humans, unlike the squirrel, have an average lifespan of 79 years. Yet we see the middle-class Indian category struggling and not reaping any benefits. According to Saurabh Mukerjea, for a couple to retire and survive for another 25 years with a reasonably good lifestyle post-retirement, they’ll need a crore a year pre-tax which is 60-70 lakhs post-tax.
This does sound reasonable considering the expenses of their adolescent children, the fragility of their health, and most importantly inflation a few years hence. This will mean that for a family to retire in a good shape they’ll need to have financial assets of at least 15 crores. Need a minute? Today we discuss an investment strategy called Coffee Can Investing that shines some light on what seeds to plant for our 15 crore oaks in the long term.
What is coffee can investing?
Coffee Can Investing was first coined by Robert G. Kirby in a paper written by him in 1984. The strategy gets its name because in the old west people who invest in the stock market would receive physical certificates of proof which they would put away in coffee cans. They would hide these cans in their mattresses later forgetting about them.
These stocks would eventually grow enormously making its holder rich when he found it again. The success of Coffee Can Investing depends entirely on the wisdom and foresight used to select stocks in the portfolio.
The Story behind Coffee Can Investing
Robert Kirby first observed the pattern dramatically in the 1950s when working in a large investment counsel organization. One of their woman clients who had just been widowed approached him. She wanted the securities inherited from her husband to be added to her portfolio under the organization. Her husband, who was a lawyer, would look after her financials.
Robert Kirby noticed that the husband had been piggybacking on the advice she would get from the advisors within the company. He would apply the advice as directed by the advisors to his wife’s portfolio. But when it came to his portfolio he would only follow those that were related to buying shares. He paid no attention whatsoever to the sell recommendations. He would simply put $5,000 in all purchases.
When Robert Kirby reviewed the portfolio created, the husband had many stocks that were worth only $1000. However, there were quite a few considerable investments that were now worth $100,000. One jumbo holding worth $800,000 exceeded his wife’s whole portfolio. These were shares of a company called Haloid. This investment later turned out to be a zillion shares of Xerox.
This surprised Kirby as the wifes’ portfolio was no match to that of her deceased husband. This happened despite the wifes’ portfolio being managed by an Investment organization. And all he did was buy the shares as suggested by the investment counsel organization but ignore the sell orders even if the stocks were moving negatively.
Coffee Can Investing and Index Funds
When Kirby first wrote the paper in 1984, he noticed that there was an increase in the index funds following. This has continued to this day. An Index in a market creates a portfolio of the top securities held in that market. The Index, however, does not hold the securities. The US has the S&P 500 Index. What Index Funds do is create an actual portfolio by investing in the securities.
In the paper, Kirby criticizes these funds as they are required to trade securities on a regular basis to keep up with the portfolio the index would have. Kirby also explains how the S&P 500 Index made several hundred stock additions and eliminations. An Index fund would actively be required to trade on these stocks. The transaction costs on these alone would have a huge impact on the portfolio and the index funds growth. Hence Kirby introduced Coffee Can Investing. He identified that leaving the stocks alone was one of the reasons why the widows’ husband had grown his portfolio enormously in the 1950s. And he also considered transaction costs from trading as the greatest detriment to superior investment returns.
What is required for a Coffee Can Strategy?
To tap into these superior investment returns of Coffee Can Investing one would have to
Carefully assess and select stocks based on the company’s performance.
Invest and forget about them for a long period of time. In Coffee Can Investing to reap the maximum benefits, one would have to let the investments be for at least a period of 10 years.
How to pick stocks for this approach?
In their book, ‘Coffee Can Investing: The low-risk road to stupendous wealth’ Saurabh Mukherjea, Rakshit Ranjan, and Pranab Uniyal discuss how to pick stocks to create a Coffee Can portfolio. According to them, the stocks considered must be filtered in the following manner.
1. The company selected must have a market cap of at least 500 crores.
This is because we will need a company that has established itself. Also because we will need the past records of the company for at least 10 years.
2. Revenue growth of the company must be at least 10% each year for the last 10 years.
3. The ROCE of the companies must be more than 15%
The ROCE will show if the management is capable of allocating that the money put by you into the company correctly. ( ROCE = Net Income/ Shareholders Equity)
The stocks selected in the portfolio still have to be diversified. The investment must be done across industries and also across different capital classes. This would, however, depend on the investor and vary accordingly. The investor would have to keep in mind that the scope for growth is limited when the companies are too big. The potential for smaller companies to grow is much higher. This, however, does not stand true for longer periods. In long term say 20 years this benefit no longer would exist with the companies in the small-cap in comparison to large-caps.
Results of Coffee Can Investing Approach
After studying trends and putting together a portfolio, The book ‘Coffee Can Investing: The low-risk road to stupendous wealth’ brings forward the concept of Patience Premium. As per Patience Premium, a period greater than one year would give you a higher probability of higher returns. Investors are not really rewarded much for periods like 1 year or even up to 7 years. The chances of returns as per the book even reduce during the 3 to 5 year period. After the 7-year and 10-year mark, the patience premium is much higher.
The best-case scenario occurs when patience premium combines with quality premium. Quality premium is the premium associated with the quality companies selected in the portfolio. A dream mix would be of good quality companies selected as per the Coffee Can portfolio filter and an investor letting the investment be for a long period. With both the premiums combined the probability of losing money is -3% yearly. After a period of 10 years, the returns would stand at 20%. They would, however, remain stagnated after this period. Hence 10 years onward the returns expected will be more or less 20%.
Why do the returns stagnate after 10 years?
Pranab Uniyal explains this citing reference to the book ‘Mathematics of everyday life’. According to the book, large numbers behave differently from small numbers. They use a dice analogy to explain this. Say 3 people were each to roll a dice 5 times. The average obtained from rolling the dice 5 times will vary or have an extremely high probability to vary from each other. On the other hand, if all of them roll the dice say 1000 times, the average will cumulate to 3.5 for all of them.
Similarly in investing. Short periods will subject us to market volatility, which would be the easiest way to lose our investment and the results would vary too much to different investors. However, when we look at longer periods say 10 years if different investors create a Coffee Can portfolio the returns would converge at 20% yearly.
Greater the Risk, Greater the reward?
The book also challenges the quote on every investor’s tongue which says more the risk, higher the reward. Coffee Can Investing provides a way for investors to earn huge returns on their investments instead of gambling in the short term. These returns can only be achieved however only if the portfolio is held for a long period of time. One of the major reasons the investor earns here is by saving up on all the transaction costs.
Why not select assets outside the stock market?
Only 2% of the Indian population indulges in the Indian stock markets. Over 95% prefer to invest their savings in Land and Gold. This could be because we as people tend to put our trust in assets that we can see and touch. Also, a great deal of cultural influence is at play when it comes to gold.
The land came to be considered as one of the best investments due to the boom in the period between 2003 to 2013. Due to this India has currently become one of the priciest markets in the world. But the prices are not followed by an apt demand. This has left a lot of unsold properties in the market. This has made land and gold one of the worst investments in recent times especially if one wants to stay ahead of inflation. And an even worse investment if they want to compete with the stock market.
Benefits of Coffee Can Investing
1. Minimum Expenses
Coffee Can Investing can be said to have been built on this factor. Apart from the cost that occurs during the one-time investment, there will be no more transaction cost for the remaining 10 year period. Tracking an index involves multiple additions and eliminations to a fund portfolio. Due to this, the investments are affected regularly from brokerage and other expenses transaction costs.
In addition to this investment management firms have their own set of charges charged to the investors. Expenses to the investment manager are spread to all the funds and not just Index funds. Also, the quest for alpha in the market has investment managers charging investors for their apparent skills. However, for the period the investors remain the market we rarely see them beat the markets.
A Coffee Can Portfolio created by the individual would not have an Expense Ratio. Also, investors rarely consider how taxes affect their investments. Regular purchases and sales would result in added taxes on any profit earned.
2. No need for tracking the portfolio.
This is also one of the necessities of Coffee Can Investing. Once we have filtered and achieved a portfolio of quality stock the only thing that is required is for them to be put aside and left alone for a decade.
When we invest we unfortunately always try and keep track of what is going on with the company. CEO changes, political and other economic changes would all stimulate us to act on our holdings. In fact, a Coffee Can Portfolio would even require us to not even look at our stocks during the pandemic.
3. Not Affected by volatility
The filters to create a suitable coffee can portfolio ensures that only the best stocks as per the present scenario make it to your portfolio. However, in the short term, these stocks will face very high volatility in reaction to the market, political, and other changes. In the long term, the stocks will only be judged by their intrinsic quality. However, even if a few stocks turn out to be bad investments it is best to cite what Kirby saw in the deceased husbands’ portfolio. There were stocks that did not perform as well as the others but they were more than made up for by the stocks that performed better. In the long term, the portfolio will face reduced impact from market volatility.
4. Outperformance by 8-10%
According to ‘Coffee Can Investing’ a portfolio that has followed all the steps will be performing better than the market and beating it by 8-10%
Why don’t funds just follow Coffee Can Investing?
If this investment strategy enables you to outperform the market by such a large margin then the question arises as to why shouldn’t mutual funds just follow this investing strategy.
— One of the major reasons is the wait for 10 years. In Coffee Can to judge how you have performed, you will have to wait for over a decade. Very few investors would be willing to commit to such a fund.
– Imagine a scenario where a fund does start coffee can investing. It would have to set up a team that would prepare a portfolio for the fund. What next? Coffee can would require you to simply ignore the investment for the next decade. Setting up a fund only as Coffee Can will have a huge setup cost at the beginning with returns only after a decade. In regular investment firms, the employees are rewarded for the right decisions, investments, and performance. These benefits would only be available to the employees of such firms only after a decade. This would be highly unfair to them.
Despite Coffee Can Investing not being popular in the Indian markets there still are a few Asset management companies still offering the coffee can route.
Closing Thoughts
Coffee Can Investing makes us question if we really are investors. Or due to our reaction to every market change has resulted in us inadvertently become traders. Traders holding the facade of an investor.
At the end of his paper where Robert Kirby introduced Coffee Can Investing, he makes it clear that his argument wasn’t against index funds. They were directed towards the transaction costs, brokerage fees, taxes that are associated with every trade. Instead, if the stocks are just left alone they would perform much better
What should an Investor with limited liquidity do?
If we take a regular Indian Investor, for him to be expected to contribute a huge amount for the one-time investment would be unrealistic. Instead if one would want to follow coffee can investing but is not able to set aside a huge amount at once it would be better if he does the following.
Create a coffee can portfolio where the investor invests what he can and set it aside for a decade. When he has saved enough again say in a year, create a coffee can portfolio which is completely independent of the one he created earlier with no references to it. It should be solely based on the market conditions prevalent filtering companies based on the present scenario and set it aside for a decade.
Coffee Can Investing: The Book
For a thorough study, I would recommend giving ‘Coffee Can Investing: The low-risk road to stupendous wealth’ by Saurabh Mukherjea, Rakshit Ranjan, and Pranab Uniyal a read. Although there might be quite a few books out there on investing there are very few books written keeping the Indian Markets particularly in mind.
It would be highly rewarding to break the loop mentioned in the introduction. Happy Investing.
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
5 Psychology Traps that Investors Need to Avoid: Benjamin Graham once said that “an investor’s chief problem and even his worst enemy- is likely to be himself.” It is a well-known fact that the human brain is a wonder that is capable of numerous mathematical, problem-solving and communication skills that is unparalleled with any other living species.
However, when it comes to investing, humans have been known to make terrible decisions and often fail to learn from their own mistakes. They go through a ‘roller-coaster of emotions’ as shown below.
While the human mind is incredibly unique, people still fall victim to the investor traps that can have serious consequences in the financial markets. This has led to the emergence of behavioural finance, a new field that aims to shed light on investors’ behaviour in financial markets.
This post discusses the most common psychological traps investors need to overcome to increase their chances of earning high returns.
5 Psychology Traps that Investors Need to Avoid:
— Anchoring Bias
Anchoring Bias occurs when people rely too much on a reference point in the past when making decisions for the future- that is they are ‘anchored’ to the past. This bias can cause a lot of problems for investors and is an important concept in behavioural finance.
For example, if you had a favourable return on a stock when you first invested in it, your perception on the future returns of stock is positive even when there may be clear signs indicating that the stock might take a dive. It is important to remember that financial markets are very unpredictable so you need to remain flexible and seek professional advice when not-sure of making considerable investment decisions.
— Herding
Also known as the mob mentality, is a tactic that was passed on from our ancestors and believes that there is strength in numbers. Unfortunately, this is not always the best strategy in the financial market as following the crowd is not always the right move.
Ironically, this herding mentality among investors is the major reason for ‘bubbles’ in the financial markets. Investors often ‘herd’ to secure their reputation and base their decisions on past trends or on investors who have had success with the same stock in the past. However, people are quick to dump stock when a company receives bad press or go into a buying frenzy when the stock does well.
As an investor, you should perform your own analysis and research on every investment decision and avoid the temptation to follow the majority.
— Loss Aversion
Loss Aversion is when people go to great lengths to avoid losses because the pain of a loss is twice as impactful as the pleasure received from an investment gain. To put in simple terms, losing one dollar is twice as painful as earning one dollar.
As emotional beings, we often make decisions to avoid a loss, this could involve investors pulling their money out of the market when there is a dip which leads to a greater cash accumulation or to avoid losses after a market correction investors decide to hold their assets in the form of cash.
However, this perceived security of exiting the market when it is unstable only leads to a larger amount of cash circulated in the economy which results in the inflation. During the 2007 financial crisis, there was $943B worth of cash increases in the US economy.
Investors can avoid the loss aversion trap by speaking to a financial advisor to learn how to cut their losses and optimize their portfolio for higher returns.
— Superiority trap
Confidence is an asset when it comes to investing in the stock market, but over-confidence or narcissism can lead to an investor’s downfall. Many investors, especially those who are well educated and have a good understanding of finance and in the functioning of the stock market often believe they know more than an independent financial advisor.
It is important to remember that the financial market is a complex system made of many different elements and cannot be outwitted by a single person. Many investors in the past have lost large sums of money simply because they have fallen prey to the mentality of overconfidence and refused to heed anyone’s advice. Overconfidence is the most dangerous form of carelessness.
— Confirmation bias
Confirmation trap is when investors seek out information that validates their opinions and ignores any theories that refute it.
When investing in a particular stock that believe will result in favourable returns, an investor will filter out any information that goes against their belief. They will continue to seek the advice of people who gave them bad advice and make the same mistakes. This results in biased decision-making as investors tend to look at only one side of the coin.
For instance, an investor will continue to hold on to a stock that is decreasing in value simply because someone else is doing the same. The investors help validate each other’s reasons for holding on to the investment, -this, however, will not work in the long-term as both investors may end up in a loss. Investors should seek out new perspectives on a stock and conduct an unbiased analysis of their investment.
How can an investor overcome these psychological traps?
The human mind is very complex and there are many factors both internal and external that can affect the decisions we make. The pressures we face in society make it easy to feed into temptation and fall prey to the psychological traps listed above. Being overconfident, seeking validation from others and finding comfort in other people who are in the same boat as you are just some of the reasons that can have an impact on the investment decisions we make.
Nobody is perfect and it is only human to fall into a psychological trap. The best way to mitigate these effects is to stay open to new information and think practically about how the investment will affect you as an individual. You should also seek the advice of industry experts to ensure that your investment decisions are based on well-researched information that can help you make unbiased decisions.
Complexity bias means that the complex concepts in our lives are better than the ones which are more straightforward. It is a way through which our brain is hardwired to think that using the source of complexity bias in our lives, and we can have a productive ordeal. It is a logical fallacy that leads us to believe that the complex problems are better and they are happening. The whole term of complexity bias denotes that people are instead devoted to their time on these kinds of approaches rather simpler, faster, and easier to solve.
Examples of Complexity Bias
Simple things made Complicated... Here are some of the most common examples of complexity bias.
1. The use of Jargon in everyday life states the fact that complexity bias is a part of us and how we use the source of complex behavior management to get. When you are trying to talk out of something or trying to evade a type of argument that is going among you and other people, then you will tend to think that using long and big words can help you to keep out of the trouble and the mess. It can keep you safe, as well.
2. Coming to the source of mathematics, let me prone an example here. When you were a kid or let us take an example of when you were in high school, did you think that the complex mathematical problems are accurate? This means that people often tend to believe that if a problem is harder to conceive, then it can say that there is a valuable quantitative insight into that problem, and it needs to have a better approach towards the whole solving issue. This is how our brain presents us with the same.
3. Another example here is the use of the software. When it comes to the management and the use of software, then you can check to see that the complex ones are the ones that you tend to like. Do you know why? Because this is a product of complexity bias as well. If we think that software is sophisticated, then our mind races into thinking that the use of the software can be kept and put together into different means. It will yield fruitful results just because the software has a complex nature and approach.
How can complexity bias be a problem for you?
Well, if you cannot asses the problem now, then let me tell you, a complexity bias into your behavior can tend to do a lot more damage than you think. Do you know why? Because with the use and sourcing of our mind into thinking that a complex behavior will help us to change routes, we tend to do things and tend to adhere to those things which can only show and procreate as complex in front of us. It can be wrong because it can cause a lot of problems later as well.
Regularisation is a fundamental concept which happens and takes place in our mind. For example, when we see people who are taking care of their management and business and doing the things they love, then we do tend to extend our behavior with respect to do. The same happens when we set our goals in life. If we have a more straightforward nature and a way of accomplishing those goals, then we tend to overthink and realize that they are not really what we want.
For example, if you are earning right now, then you might tend to of your taxes at the same time. Well, if you have the complexity bias, then your mind will fool you into thinking that the bigger the problem, the better will be your answer. A lot of people do believe that their goal can only be achieved with the use of sophisticated means, and this entirely happens to the inner sane that we create within us. The same happens and takes place with the source of complexity bias here. With the use of this terminology, people tend to think that the complex their life problems are, the better they can thrive towards their goals.
How to stop complexity bias from protruding your life?
If complexity bias is a constant problem in your life, then don’t worry because you are not the only one here. In a famous survey, it was found that around 56% of the people tend to have complexity bias based on the behavior that they possess. They think that the complex problem will yield them more, and they tend to move towards the one which is harder to solve.
The same happens when you are a kid. If you think that severe problems should be solved first because they are more rewarding than others, then there is where you are wrong. The source of complexity bias is that it blinds our senses into thinking that everything in life, which is simple and healthy, can yield better choices and results too. We tend to feel the same because our brain is wired in that way.
Have you ever been in a situation where you have felt that the complicated situation is, and it will be easier for you to get out? What was your final solution? Did you get out eventually? Well, around 10 out of every 15 people who have the source of building complexity bias don’t actually get out of a problem. They tend to think that they will do, but then they get stuck.
Take this as an example. A Couple has borrowed money from one man, and they think that they can use the money and borrow another loan from someplace in a shorter time to pay to the man. This is when the couple starts to borrow loans from everyone, and instead of choosing to pay them off, they begin to fall into a loan loop. This is because the couple does have a source and tendency to show complexity bias.
It is better to get a bird’s eye view:
Have you ever thought of getting the bird’s eye view to solve your complexity bias issue? Well, if you have not, then it is your time. With the help of the bird’s eye view, you can see everything that you want. When you are doing something, then they are ‘bound to affect the people who are around you. If you are taking a loan, then your partner is bound to be affected by the same. It is essential that you get a 360 angle and view up from the sky.
As a source writer, I am often presented with a ton of complex ideas and contents to finish. But the ones which are simpler is easier to be done. When I do get the miscellaneous items, trust me, I think that they are useful because they are technical, and they can yield me more value than the others. But what I don’t asses and realize at the same time is, the complex my topics are, the harder it gets for me to understand and how to write on them. And the harder it gets for me to formulate a story in a simple language so that I can tell it to anyone or the readers who read it.
This is when I need to approach and look at the whole problem into the source of the bird-eye view and point here. With the use of the bird’s eye view, I can calculate the origin and function, which can be yield with the use of the simple articles which are collected at my place. It might be simple for me to write, but at the same time, they can yield me many more views too.
Here is how you can do the needful and get the thing I am talking about.
When something is presented right in front of you, don’t procrastinate with it. You need to understand how and why you need to do it so that you can maintain the source of your work.
Write it all down on a piece of paper if you want. If you want to have a good time and keep yourself away from your complexity bias, then writing down everything in a piece of paper will save you from the troubles later.
And the third thing you need to do is rule out the negative that you have got. If you have negatives in your line of business, then you need to understand how you can work through it. You cannot rule out the images for you, but what you can do is, help yourself out from keeping them away from you.
Get a perspective that can help you and the ones who are staying with you. You need to have a proper outlook over the items that are holding you down for the source of your complexity bias. This can only be done with the use of the full point of view that is being talked out.
Ask yourself the right questions when you are divulging
Another type of source and problem that can be laid and help you out with your complexity bias is to ask yourself the right kind of the issues that you have. If you don’t ask and question yourself, then you are never going to get things moving in your life. You need to have a proactive session with yourself and understand that the rights and the wrongs depend on your view and the perspective. It is entirely on you.
Here are some questions you can divulge in.
Ask yourself that if this is the right thing that you are doing or not?
Make sure that you keep your time out on the following and understand the source of complexity bias in your life. You need to dive in deep, and this way, you can find a cause or a means through which to get out of your complexity bias-based behavior.
Ask yourself that the complex problems that you intend in your life will yield you something or not?
Ask yourself the general questions like the assessment of the work and how it can be managed for you? You need to look out for you, and this can only be done with the source of you questioning all the details and the intricate source of your life.
Ask yourself that these complex problems that you are undertaking for yourself won’t cause you damage or not?
You need to think before you act, and this is the prime solution for getting over your complexity bias. It can help you to manage the best, and in the right way, these top questions will help you to get over the type of behavior which you generally possess.
Conclusion
Always have an excellent tactic when you are asking yourself some questions. Always remember that people, when they have complexity bias, they tend to over-complicate even the simplest of things. It is better that you ask for a piece of needed advice from your peers if they are sorted out. Or, if you want, then you can look for professional help if the simple things are not yielding much into your life. The more you indulge in these, the more the behavior will grow on you and which can later yield to something complicated to eradicate.
Recency bias is a psychological phenomenon where a person can remember something which has happened to them recently compared to the thing that has happened to them a while back.
For example, to conduct a test to check this phenomenon, a person is asked to recall the name of the thirty people that they have met. Well, out of the thirty people, the person will easily tend to remember the names of the people that they have met recently compared to the ones that they have reached a long time back.
Recency bias is the main type of cognitive error that happens to the human brain. It is one of the errors which plagues a lot of traders and investors. It tends the human mind to remember the recent data that are happening in their lives and forget the ones that have happened a long while. With the help of this article, you will understand what causes this problem and how well you can overcome the problem of recency bias in your life if it is affecting you on the financial scale as well.
Why it is your enemy as an investor?
Recency bias is the description which tends to extrapolate the recent experiences that will happen to you in the future. When it comes to investing, recency bias is one of the biggest disasters that they can face. Because when investors try to invest, the recency bias skews the entire reality in front of them, and this is how their views can change from choosing something to selecting another thing.
For example, let’s say that an investor has been making a good average annual return in the last 5 years. However, in the last twelve months, his portfolio is not giving good returns. Here, because of recency bias, he might feel negative and may believe that the market and his strategies are not working in his favor anymore. However, this is not the complete reality.
Similarly, for a trader, let say that out of seven days, he made losses in the first four. Nonetheless, in the last three days, he made consecutive wins. Here, he may feel positive as he might be carrying more weight to his recent trades over the past ones because of the recency bias.
Moreover, many times, investors may tend to stay away from shares thinking that the stock market will fall because it has been falling recently. That is not the case which happens every time as the share market is not always the same. You can never put your trust in it based on recent behaviors.
How to overcome the recency bias?
If the recency bias is becoming a day to day problem then there are proven ways to overcome it. Here are some of them presented below.
— Don’t ever have a myopic view.
Get a grasp on the long term source and try to invest in the market that way. A myopic view means that you are constricting yourself to the four walls of the market, and you don’t want to try something new. You might fall when you are trying to invest somewhere, and there are gut-wrenching actions that might happen as well. But since recency bias helps you to build your views based on the latest outcomes, try to overcome it by thinking about the bigger picture in your life. Just try to expand your opinions as much as you can.
— Always try to work in with what you have in control.
Control all the asset allocation that you have. Try to stay away from the bad investments in your life. Setting realistic expectations is something that can put you down and bring false hopes in your life. Always try to remember the fact that recency bias feeds on the belief that you have in your life. Try to minimize the risks that you have built on your front. Use the thesis and help of the finance operators for your investment business if you have one. They will try to cut them down for you.
— Don’t ever try to get swayed with the latest performance.
As a smart investor, you should not ever try to get swayed with the latest performance or the numbers that are popping up in your life. You always have to understand that something in your life is just a temporary digit. Just like the numbers that you are making in the market to the points that you have scored, not always they will stay the same. So raising your expectation based on the higher numbers is a silly movie, and here is where recency bias plays a part in your life.
Always try to understand that cyclicality comes with a lot of terrains. There is not a smooth road that you can take to success. If you are trying to get the best thing in your life then there are a lot of ups and downs that you have to face. But you should never determine the outcome or the results based on recency bias.
Recency bias is a brain illusion that happens when you see the latest issues. It is your very brain tricking you into thinking that the same will happen for a couple of other days, as well. Find appropriate assistance if you are finding it hard to let go. There is always assistance if you are trying to look for one.
So let us begin from the start about what is the theory behind the Maslow’s Hierarchy of Needs. As we all know, Human behavior is complex. And, to understand the basic of it, you need to dive into the deep level of science. Well, human behavior is the combination of both science and art, so here is an essential prime factor and explanation of it.
In the layman or the economic term, human behavior is based on wants that we generate towards the same kind or towards materialistic items. For example, if someone sees a dress at a store and it is pretty then their instant thought is to buy that dress. This type of human behavior is categorized into a section of wants.
Maslow said and proved that human behavior is a series of complex happenings in the mind of an ordinary human being due to motivation. The main factor or the module of this explanation lies in the motivational factor, which rules human behavior.
A close look at Maslow’s Hierarchy of Needs
Maslow first introduced his needs theory in the year of 1943. This was published in a journal back then because people then never had smartphones or tablets. The weekly or the writing was published under the name of ‘Human Motivation and its Theory,’ and he even wrote a book about the same. This Maslow’s Hierarchy of Needs suggests that there are specific needs that arise in humans, and they can be categorized in the form of a pyramid.
The topmost of the pyramid is the one that comes at a high level. And the last part is the one which humans need the most or which cannot be delayed. While some of the people criticized his working theory on the needs of the human mind, he suggested that the cycle of life happens with the hierarchy which he has produced in his book.
Maslow did tell that he was always interested to know what made people feel happy, secured, anger, and this, in turn, raises the level of needs inside their mind. With all due respect, we know that the human brain is complicated and debunking it can be hard work but if we categorize ours wants to different sections that we have then it is going to be easy work for us.
As a humanist Maslow believed the same. He wanted to know what the self-desire that people wanted or which could also be counted as the self-actualization needs, which comes at the very top.
There are five different levels of the Maslow’s Hierarchy of Needs. The first starts with the self-actualization needs then it shifts down to the esteem needs. Then it goes down again to the belonging needs, then to the safety needs and later to the psychological one.
From the basic level to the complex one
When you understand Maslow’s Hierarchy of Needs, you have to realize that there are two types of needs that a human can have.
One is the basic needs like the need for safety and shelter. Or to have food when they wake up in the morning. And the next one is the complex where a human needs to understand his self-esteem. The self-actualization means that a human has to follow his full capacity so that they can only reach the top of their life. So it is sorted.
When it comes to the wanting of needs, then humans go for the basic at first and then they choose to select onto the complex at later.
The pyramid, which is present for Maslow’s Hierarchy of Needs refers to the needs and what they relate to the mind of a human being. When a person progresses and has the safety or the necessities that they want, they move to the need of being loved. This comes in the middle where they rise, and this is where their self-esteem needs grow. This is when someone tries to question their behavior and attitude toward something. The topmost level of the pyramid consists of the actualization needs or the standard. This is where a human needs to understand his boundary and his limits to what he/she can achieve in their lifetime.
Breaking down the Pyramid
Here is how the requirements are broken down, which are present at the pyramid.
1. Psychological needs
These are the most common or the primary type of requirements that a man/woman can have. These are also known as the apparent needs which you have to get in your life to survive. Some of these needs include having the food to eat, a shelter, or a place to stay, the need to breathe and live. In the essential requirement of these needs, there are nutrition and air which are added here as well.
Maslow also included that the need for sexual reproduction comes to this point. This is because, for our population to grow and move forward, people need to mate with each other. And this is one of the most common or basic needs that they can have.
Coming to the next or the upper level of the pyramid, there lie the safety needs. This means that a human being in order to live should have a minimum safety in their lives. At this level, their need for security and safety becomes quite apparent. People who want to have control over their lives and the things that they are getting needs to have the safety needs issued here.
Some of the necessary safety needs are financial safety, health, and wellness safety and the security needs that they want from injuries and accidents. People need to obtain an excellent job so that they can be financially dependent and stand on their own feet. And they should have a basic safety on how they are living which matters to their well-being as well.
3. Social needs
The third one is called social needs. This means that in order for the average or an ordinary human being to live in society, they need to have a basic social need. These are the things that can satisfy the human mind. This need in Maslow’s Hierarchy of Needs helps a human to understand the meaning of being loved, respected, and accepted socially into a group.
Here are some of the breakdown of the needs. The need of being loved, the lack of having romantic attachments, having a healthy family, a group of friends, being accepted to community groups are everything that lies here in this need. To fight mental disorder such as depression or loneliness, social needs are the part which helps a human being. This is to feel being loved by their opposite sex or by their family members.
4. Self-esteem needs
At the fourth level, which comes for the Maslow’s Hierarchy of Needs, it is the self-esteem needs that are talked here. So what are they? Well, self-esteem is something which is a part of your day to day life. It is the need for being appreciated and have respect for the work that you do. When the requirements which are left at the bottom of the levels are satisfied. This is one need that appears inside your mind.
We, as an ordinary human being, need to be recognized by the others. We have a compelling need where our self-esteem and ego comes, and we identify them. Even though they are not the basic needs, they go and lies in the complicated part here. At this point, after you have complied with the basic needs. And, it becomes increasingly crucial for you to gain respect for the work that you do for others and even for yourself. This is an appreciation or needs that you want from others.
5. Self-actualization needs
The top of the pyramid lies for the self-actualization needs or the need to actualize your wants. At the peak, it lies, and it explains the conditioning of the human brain to attain the kind of desire that they have towards a sure thing.
For example, self-actualization needs mean that you realize what you are capable of. Maslow explained that this need means ‘it is loosely based and describes the full use of the human mind in regards to the talents, potentialities that it might have, etc.
For the summarization of the entire Maslow’s Hierarchy of Needs, here is the essential thing.
The human mind is the complex structure of our life.
There are two kind of needs which can happen inside our mind called the basic and the complex requirements.
There are five needs that can occur inside us.
The first is the psychological need or the basic level of need used by people.
The second lies in safety needs like safety for financial issues and other guarantees.
The third is the psychological need which uses a human to function on the basis of emotions.
Esteem needs stand at fourth and that’s where the respect is marked.
The fifth one is called the actualization need or when a person understands his/her entire potential.
The Maslow’s Hierarchy of Needs is a diagrammatic module of how our needs are categorized and based. The higher you move, the complex your need becomes. And mostly Maslow has said that the requirements are based on the income level of the people too. People who have reduced income are more opinionated towards the primary type of the lower level of the pyramid.
And those for the higher section of the society have an opinion for the higher base for the pyramid. There are potent motivators from all around which works for the people to enhance their needs as well.
In this article, we will help you to understand the fuel of what triggers your fear of missing out, which is commonly known as FOMO. It has become a popular internet term for teenagers to use these days because according to a recent survey, it has been said that around 6 out of every ten teenagers have been faced with FOMO. It is the feeling of constant depression and anxiety in you that you are being left out from your social groups and even your own family. While others are having an exciting event, you are always being left out or pushed to the corner.
The term may be new to some people, but it surely is not. FOMO has been happening for a long time now, but since science was not so evolved back then, people commonly mistook it as depression. If you have FOMO or you are suffering from it, then you are at a constant understanding that someone out there has it better than you or doing better than you.
Especially the fear triggers in this digital age since we always tend to check on each other’s profile to know how we all are doing. And this, in turn, is creating a void or space in us, which is keeping us away from confronting the constant struggles that we are facing due to this hard-hitting mental disorder.
From where FOMO( Fear Of Missing Out) comes?
FOMO is a common phrase that is used by the millennial these days. They might be able to explain the fact of what is happening to them, but most of them lack the intellect to explain how it happens. So here comes and lies the main question. How is FOMO(fear of missing out) affecting your life?
Well, FOMO mainly occurs because the advent of social media has created dawn on time. With the use of the more extensive function of social media, each and every one of us are comparing our lives to the people who are living online.
Mainly this happens with the top influencers that you see on social media. Sure at the age of eighteen or sixteen, they are making a massive load of cash but what you see on your screen is not what happens in the real stage of life.
Social media is causing a wave of depression in children or millennials. They are trying to live their life as their’ so-called influencers’ but often end up thinking about how insecure they are. This comes with added symptoms like depression, anxiety, inferiority complex, lack of communicational skills, etc.
FOMO creates a distance of you from the outside world, and this is why the teenagers are always locking themselves up in their bedrooms and weeping over countless things. FOMO can trigger a lot of health issues as well, which in turn can cause these people to binge eat or go without food for the whole two days or more.
How to overcome FOMO?
When you first started to learn a car, did you rapidly learn how to shift the gears too? Well, the same thing is done here as well. Surely you are suffering from anxiety and depression, maybe even a lot more than others, but you have to take gradual steps so that you can overcome mental disorders such as FOMO (fear of missing out).
Here are some tips and ideas which you might need to follow if you want to embrace your JOMO (the joy of missing out).
1. Slow down and move at a pace. You need to stop rushing down the things that you do physically and even the items inside your mind. Practice some time out when you are eating, talking, making a pleasant conversation with someone. These days, we are always in a hurry to leave for things, but it inevitably becomes an essential or crucial part of our lives to slow down and enjoy the smallest joys that life has bestowed on us. Set a mental reminder to yourself. You need to feel the things that you are doing every day. Make sure that you are not doing in terms of a chore. Instead, love the things that you are indulging yourself in.
2. Go for the experience and collect the memories in your life. It might feel like a stretch to you, but if you are going for the symbols, then you are wasting the potential years of your experience. If you want to do drugs just because your friends think that it is fresh, learn to say no to them. Instead, pack your bags and ditch your phone and plan a hiking trip with your family or even your best friend. Studies have shown that people who take adventure as a course part of their routine are more likely to rejoice in life.
3. Be willing to say no to things. If you are obsessively stalking your crush’s page on Instagram and finding that he/she is posting pictures with their near-perfect dates, you are going to feel the pangs of depression right inside your heart. This is the prime reason why you have to learn to say no to your mind. Always remember that a sound intention is hard to overcome. Whatever challenge may come to your way, stay determined towards the goal that you have set for yourself. Don’t falter, and you will surely get the results.
4. Do one thing at a time. Yes, you might think that you can overcome the fear of missing out while you are multitasking, but instead, you are putting in a lot of pressure on yourself. You need to focus on one thing at a time to understand the importance of the subject that you are swelling with. Psychologists have said that our mind is like a speeding race car. You might put to any gear, and it will shift the pace. If you want to stop your anxiety due to FOMO, you need to settle down and calm for a bit.
Surely mindfulness can help you to overcome FOMO. Rather than chasing what you cannot have in your life, you need to understand that the best things take time. Pursuing the things that you want in your life will create a false sense of happiness. It will be for a short period of time, but eventually, it will fade away.
To overcome your FOMO, you need to be aware of your surroundings and in the right way. Once you have learned to master your mind, you will eventually find a better cure for yourself.
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