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The (not so) indomitable investor

by Oct 16, 2019UpClose

The (not so) indomitable investor

by Oct 16, 2019UpClose

9 reasons most investors lack the discipline to succeed.

Steven M. Sears, senior editor and columnist with Barron’s, took a hard look at investor behavior—both typical shortcomings and the unique qualities leading to positive results—in his 2012 book, “The Indomitable Investor: Why a Few Succeed in the Stock Market When Everyone Else Fails.”

Sears brought a rich background of achievement to his task, as both a reporter and executive with two major exchanges. Sears has reported for Dow Jones and The Wall Street Journal, covering most major modern financial events, including the Asian Contagion, the bursting of the internet bubble, the credit crisis, and Europe’s sovereign debt crisis. He was also part of exchange executive teams that modernized the U.S. options market and introduced electronic trading.

Sears’ overall message carries great import for advisors, asset managers, and the industry of wealth management and financial services as a whole. The book’s introduction sums up his major premise:

“The financial crisis of 2007 was a serious wake up call. Most people realize they may never lead lives of financial ease, but now many live in fear of never even retiring. We must think how we approach investing—and even acknowledge we never understood it in the first place—before it is too late.”
“We must think how we approach investing—and even acknowledge we never understood it in the first place—before it is too late.”

Related to the theme of Sears’ book, independent research conducted in the middle of 2014 showed that an unusual phenomenon had occurred within a broad swath of the retail investing public.

There was a barbell distribution between those investors suffering from a euphoric “short-term market memory loss” and those who remain paralyzed with “loss aversion.” Neither state of mind will be conducive to prospering over the long haul in the equity markets—underscoring the importance of Sears’ thesis.

While not necessarily known as a proponent of active investment management, Sears highlighted many concepts central to the core principles of that discipline. His first chapter, for example, states,

“Bad investors think of ways to make money. Good investors think of ways to not lose money. Those 17 words are the most important words any investor can know. Learn the meaning of those words, and you have a chance of real success in the stock market.”

So, what are the specific traits, investor behaviors, or attitudes that help Sears define the challenges facing most investors—and that are still highly relevant today?

1. Not understanding risk

Sears quotes Arthur Levitt, former chairman of the SEC: “Too many people don’t know how to determine saving and investment objectives or their tolerance for risk. … They don’t know how to choose an investment, or an investment professional, or where to turn for help.”

2. Greed
“The great crowd that comes to Wall Street to make money mostly ‘greeds in and panics out.’ … Rising stock prices are seductive and it is easy to believe they will continue to rise.”
3. Fear
“Fear causes rational people to ignore the financial facts that shape the prices of stocks. … People sell based on emotional reaction to the news, exacerbated by the crowd’s behavior. … What is the personality of the most successful investors, according to neurologist and money manager William Bernstein? They aren’t affected by other people’s feelings.”
4. Misuse of information and news
“You must learn to use the news and not let the news use you.” Sears describes a modern-day information hierarchy as it pertains to the investment world. He says, “The challenge for investors is focusing on known unknowns and preparing for unknown unknowns (Black Swans). … People think they are making smart rational decisions in response to information, rarely realizing they are chasers of smoke.”
5. Not preparing for market chaos

“Volatility is globalization’s side effect. … To avoid getting crushed you must make friends with volatility. … ‘Blackswanning’ investment portfolios has become a cottage industry on Wall Street, adopted by the upper echelon of the financial market. … Modern Portfolio Theory (buy-and-hold diversification) is no longer adequate all by itself.”

6. Lack of due diligence
“The discipline of questioning how your money is managed applies to all areas of your financial life. … A healthy skepticism will serve you well.” Sears covers a wide variety of issues under this umbrella, sparing few sides of the financial-services industry from scrutiny. He does not make sweeping judgments, however, essentially concluding that the prime consideration of any transaction or relationship with the industry ought to be, “Does it consistently add value?”
“Bad investors think of ways to make money. Good investors think of ways to not lose money.”
7. Misunderstanding market cycles and patterns

Sears reviews how seasonal, secular, and economic patterns can influence the stock market but also be grossly misused. “Patterns influence stock trading like magnets attract slivers of metal—except when they don’t. … They can be a prism to better focus the market but not a foolproof trading system. … The least knowledgeable people feel the most empowered by the (pattern) information and act because things are supposed to happen.”

8. Irrational behavior
Sears reviews the growing importance of behavioral finance theory, from “anchoring” to the effects of the “casino culture.” His bottom line? “Biases tend to emerge when making complex decisions with uncertain outcomes, like investing. … Major psychological pitfalls hurt most investors most of the time.”
9. Financial literacy, or lack thereof

Sears says that despite massive technological and financial innovations, certain things will likely never change:

  • The boom-and-bust cycle of the markets.
  • Regulatory, government, and financial institutions that are either ill-equipped or unwilling to protect individual investors.
  • A Wall Street environment that is complicated, hard for most to understand, and merciless in separating investors from their money.

His proposed solutions are extensive changes and initiatives to address investors’ financial literacy, to safeguard their interests, and “close the chasm” between Main Street and Wall Street. But, acknowledging that this may never happen in full, Sears encourages investors to adopt the tools of the most sophisticated market participants, either through their own efforts or through trusted advisors.

People who win the most, says Sears, are the most disciplined and fully understand that “successful investing is always a matter of controlling risk.”

The opinions expressed in this article are those of the author and do not necessarily represent the views of Proactive Advisor Magazine. These opinions are presented for educational purposes only.

This article first published in Proactive Advisor Magazine on June 26, 2014, Volume 2, Issue 12.

David Wismer is editor of Proactive Advisor Magazine. Mr. Wismer has deep experience in the communications field and content/editorial development. He has worked across many financial-services categories, including asset management, banking, insurance, financial media, exchange-traded products, and wealth management.

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