On the morning of the Battle of Waterloo in 1815, Napoleon Bonaparte smugly assured his generals – “I tell you Wellington is a bad general, the English are bad soldiers; we will settle this matter by lunchtime.”
Just before the Titanic was about to embark on its maiden journey in 1912, one passenger asked a ship’s agent for extra insurance on some valuables in her luggage. The agent replied, “Ridiculous. This boat’s unsinkable.”
Captain Smith himself was asked about the safety of the Titanic. He answered – “I cannot imagine any condition which would cause a ship to founder. I cannot conceive of any vital disaster happening to this vessel. Modern shipbuilding has gone beyond that.”
Then, after the ship had struck the iceberg, a passenger asked her employer if they should do something about it. He replied, “Go back to bed. This ship is unsinkable.”
The New “Unsinkables”
Cut to 2008. Fund managers in India who were betting big on infrastructure and realty stocks, when asked about the valuations at which they were buying such stocks, said, “Real estate and infra are the new gold and prices will continue to head north.”
Ask me. As an analyst in 2008, I asked my friends and relatives to hold on to “great stocks” expecting that these cannot fall more than 20-30%, whatever the markets did.
As a team at my ex-employer, we were asking clients to hold on to stocks, and “buy at every dip”, despite sensing a greater danger with every “breaking news” coming out of the financial system.
The rest, as they you know, isn’t history…but reality!
Anyways, if you have sensed by now, there is a common thread that binds all the above situations and events. If not, let me tell you that that common thread is of…
If we’re repeatedly successful – like Napoleon, or fund managers and analysts prior to 2008 – we’re tempted to believe that we’ve found the formula for success and are no longer subject to human fallibility. This is devastating, especially in a world that is continually changing, and where every right idea is eventually the wrong one.
With an arrogant attitude, we cease paying attention to different points of view and information that contradicts our beliefs. Even if the world around us is expected to fall under its weight, we believe we’re not subject to the same constraints as others.
“I have done my homework,” I would tell myself after analysing a stock threadbare and finding its valuations attractive. “Now let me act on it!”
But I Might Be Wrong
Now, that’s something Napoleon didn’t tell himself before the Battle of Waterloo. That’s also what Captain Smith didn’t consider before sailing out with his “unsinkable” Titanic.
Here is what the legendary Seth Klarman wrote in his shareholder letter in 1996…
We regard investing as an arrogant act; an investor who buys is effectively saying that he or she knows more than the seller and the same or more than other prospective buyers.
This statement contains a big truth that I, as an investor, ignored all these years.
So I bought a stock because I thought my analysis was right. I thought my calculation of the stock’s intrinsic value was right. I thought my decision to buy the stock was right even when I always wondered what could be the reason someone else was selling the same stock.
All in all, my arrogance – of being right – made me buy several stocks over these years.
While I’m satisfied with my long term returns, I consider a large part of my performance a result of luck than my own aptitude of picking up the right stocks.
“Why do you say so?” you may ask.
Well, the reason is that in considering myself the most right (and thus the most arrogant) investor in the world, I often failed to tell myself the most important thing that an investor must tell himself before buying or selling a stock.
That thing is – “But I might be wrong!”
This statement now lies at every major decision point of my investing checklist…
- After I’ve done my research on a company
- After I’ve calculated a stock’s intrinsic value
- Before I make the final decision to buy a stock
After providing for a numerical “margin of safety” to my intrinsic value estimates, this statement serves as an extra layer of margin of safety – a check on my arrogance…because it leads me to do a review of my analysis and assumptions before I go ahead with my final decision.
Here is what Klarman said in an interview with Charlie Rose in 2012…
You need to balance arrogance and humility…when you buy anything, it’s an arrogant act. You are saying the markets are gyrating and somebody wants to sell this to me and I know more than everybody else so I am going to stand here and buy it. I am going to pay 1/8th more than the next guy wants to pay and buy it. That’s arrogant. And you need the humility to say ‘but I might be wrong.’ And you have to do that on everything.
This is an interesting concept, and one that I, like most investors, did not fully consider when purchasing a stock (though I’ve now learnt my lessons).
Risk is Not in Our Stocks, But in Ourselves
Jason Zweig, in his commentary for Chapter 20 of Benjamin Graham’s The Intelligent Investor , wrote…
Risk exists in another dimension: inside you.
If you overestimate how well you really understand an investment, or overstate your ability to ride out a temporary plunge in prices, it doesn’t matter what you own or how the market does.
Ultimately, financial risk resides not in what kinds of investments you have, but in what kind of investor you are. If you want to know what risk really is, go to the nearest bathroom and step up to the mirror.
That’s risk, gazing back at you from the glass.
Staying humble with your analysis and forecasting powers will keep you from risking too much in a view of the future that may well turn out to be wrong. So, by all means you should lower your expectations – but take care not to depress your spirit.
For the intelligent investor , hope always springs eternal, because it should.
I’ve learned these important lessons by being an arrogant investor in the past. Now, I’m practicing to be humble…by telling myself this before making an investment decision – “But I might be wrong” – and double-checking my analysis and assumptions.
Kunal Kher says
Good to know somebody admitting to their mistakes.What I take away from this article is that no matter how confident or calculated your investment is, it will always be prone to market moods and calculation bias.Often luck will be understood to be success.Learning from mistakes can be a great lesson.
Eswar Santhosh says
Ah! Arrogance! I know it too well.
As a new investor in 2004, I tried all forms of money making. There wasn’t a way I hadn’t lost money – day trading, stock futures, commodities, magical newsletters with rocket stocks. After a while, when it became too boring to lose money in various ways, I tried ‘investing’. From 2006 to 2008, my portfolio rose to pre-2006 levels with less than half the capital. For the first time in my life, I had plenty of multi-baggers. Then by late Dec 2007, all I could think of was ‘If my portfolio keeps going like this, then by March, I would have XXXX cash’. I clearly remember thinking like this day after day, looking myself in the mirror, proud of how I’ve mastered the art of stock picking. That image is exactly what I force myself to remember whenever I start to feel too proud of myself.
Back then, when a few experienced investors told me humility was required, I didn’t believe it. After all, I am a ‘new age’ investor living in the ‘new normal’ of GDP growth. The early crash of Jan 2008 did little to ruffle my feathers. After all, I “knew” what I was doing and kept averaging what I thought were good stocks at beaten down valuations. But then, pockets got emptied faster. Before I could finish eating my select set of candies, new flavors of candies appeared from nowhere. I knew the latter had better quality and taste, but my stomach was already upset from eating what turned out to be bad candy. I had suddenly realized that if you are not humble, markets will make you.
The first casualty of this war on arrogance was my predictive ability. Of course, I would have been right about 50% of the time, but due to selective memory, I had always remembered myself to be a better predictor of market and stock direction. This was one of the most difficult changes to make.
The second casualty was assumption of return figures. Selective amnesia about losing stocks had what led me to be arrogant in the first place. Now figures were telling me that I had assumed too much. There is nothing to kill arrogance than the humility brought about by actual numbers. I figured that frequent churning of my portfolio was only benefiting the broker. My returns have turned for the better since 2009 with far less portfolio churning.
Slowly (and it wasn’t easy at first), I’ve started forcing myself to think both ways. Even recently, when stocks were going up in Dec/Jan, I was thinking “If only stocks could go up a further 10%, I’d be reaching a small personal milestone”. But, remembering the man in the mirror from Jan 2008, I forced myself to think “…. but, what if it fell 30%?”.
I still do not consider myself a proper investor by any means – though my period of holding could be 3-5 years on average. I am still arrogant in my approach as I am primarily a contrarian. I have butterflies in my stomach when stocks move up fast, but I am at peace in sideways and down markets. But I at least know this does not guarantee success (even if this has worked well for me over the past five years). I keep telling myself that I can be wrong this time or the next.
The first five years (2004-08) – I spent on knowing what not to do. No method, pure madness!
The next five (2009-13) – Figuring out what works for me. Most work was towards understanding myself and my shortcomings as an investor. Though the returns were decent, much of it went towards repairing the damage of the first five to return the portfolio back to the desired average CAGR.
The next five (2014-18) – I would try to fine tune my stock picking and money management strategies and a spend slightly less % of time towards understanding myself even better. The latter will always remain a work in progress.
Returns, I hope should follow if I reach an optimal method that suits me! There is no guarantee, but judging by the last 5 years, there’s some hope.
Vishal Khandelwal says
What an amazing (and humble) way to share you experience, Eswar!
I’m sure each member of this tribe would have something to learn from the way you have laid down your history of arrogance as an investor – which each one of us can relate to – and how you are trying to be humble – lessons we must not miss.
Thanks again! This has to be the best comment on an SN post in 2013 so far. 🙂
Yes, agree. A very candid and informative post.
Thanks for sharing your experience and wonderful opinions.
Mind blowing confession. Hallmark of astuteness.
This holds true not just in investing but life in general. While most things fall in place as you have anticipated some will not and we need the humility to accept rather than just continuously cursing oneself.
In investing I too have lost a fair amount of money but hopefully am making some as well.
The books and guidance on this site from Vishal and fellow tribe members have been very helpful.
Way before this post, while going through one of your article i learnt the mistake of being arrogant not just in investing but in personal life too.
My way of solution to this is, I dedicate all decisions to GOD to keep check on my arrogance. If decision come out as success, then its his blessing and if it come out as failure then he is teaching me lesson to improve.
As usual great article. However, one need not be afraid of making mistakes. Key is to accept the mistake and cut your losses(I am not great in this though). As Peter Lynch says” You need to be right 6 out of 10 times to be successful” .
We have some great tribesman here. Eswar for one- thanks for sharing your ”experience”, a great learning for all. Humility personified is a great trait to have in what ever field you are in. Success is invariably attributed to ones ingenuity, when it very well could have been pure good luck, whereas failure is explained by excuses outside your domain!! It is said that, when India lost 4 wickets without a run on board in England in 1952, and the Indian commentator rued India’s bad luck, he was politely reminded that good luck is always on the better side!!
Eswar Santhosh says
In general, yes! it is easier to blame everything on luck. On the other hand, I have actually learned nothing from my ‘success’, but plenty from each of my failures :). At best, I can only say that my confidence grew more every time I dug out of the hole. Without market conditions helping me, I don’t see how my performance could have improved since 2009. I owe my ‘success’ to others who bought stocks from my portfolio resulting in prices going up, but I feel responsible for each of my missteps.
Knowledge, which in part comes from experience, is an endless spiral. When we finish one level, we simply move on to the next. When I didn’t know anything, I was observant, silent, looking for a way to start. Once I knew ‘something’, I asked questions, built knowledge and experimented. It is in this phase, I usually find getting a little full of myself. Confidence at times turns to arrogance.
With time, one learns about how less he knows and how much he does not know. There are plenty of things one feels he “knows”, but had lacked the experience or environment to properly understand it. But, some of those things suddenly clear up and become easier to grasp. The next level of learning begins there with the previous level acting as the base – somewhat like higher lows and higher highs in stocks. One who does not forget the lessons he learned could move on – despite the volatility and fluctuations in the short term. But, if one forgets, he gets punished due to poor results and has to start learning back again. Many times, the ‘sentiment’ or favorable external factor aids in lifting one up. But, our own values are what will keep us there. It’s much easier to go up, but very, very hard to regain lost ground – not just true for stocks, but also ourselves.
Right now, I would not classify myself as a growth stock or a value stock, but one who ‘wants’ to turn around. While I feel I am generally back in the right direction, there are miles to go before I could rest, so have no option, but to keep working on it! 🙂
Deepak Krishnan says
Thanks Vishalbhai :).
Once again as insightful as you are always, special thanks to Eswar also to have shared his story. have always seen this act of arrogance where its “My way of the highway style”, As Eswar says there is a thin line that separates confidence and arrogance, thanks a lot gentlemen for portraying humility. superb way to start the day 🙂