Tuesday, June 16, 2015

The most difficult part of investing

Everyone has their own process, whether articulated or not, that leads to a decision and this pertains to all decisions in all aspects of life, from what shoes to buy, to who to marry, what to eat for dinner or when to start the war. Even a random choice is a form of decision making, albeit with the most indefinite input. 

Factors that drive decisions varies by individual and let's not forget the external pressures people face making them. Twenty years ago, the truth I held dear that most others disagreed with was absurdity of the underlying concept of classical economics, that we all strive to make optimal decisions. The growing acceptance of behavioral economics has finally disabused that ridiculous notion. Few people articulate their goals clearly enough to to make "optimal" decisions and even when they do, the process can still be rife with error.  

What complicates but also inspires decisions may be the most human aspects of our experiences. 

Investment decisions are no different from life decisions, though the stakes and results are more easily quantified. 

Inputs to investment decisions varies by type of investor and may include the analysis of charts, historical earnings and cash flow, forecast earnings and cash flow, valuation, management expertise, perceived corporate strengths / weaknesses ... or no analysis at all. 

By "no analysis" I mean that for the last two years while largely focused on small cap investing, I have bought and sold no more than 15 stocks based on various levels of research, but I could have bought an ETF with 1,400 stocks in it, a most undifferentiated approach. And of the stocks I've bought and sold, some friends have bought them too, based only on my recommendation. A deeply differentiated approach with zero analysis on their part. 

While the inputs to an investment decision is a key differentiating factor between investment managers, the inputs to the inputs matters as well (how many years back were earnings analyzed? how many industry experts did you speak to?) as do the weights assigned to the inputs (how important was that incremental piece of information you just received?).

I have come to the understanding since moving from the sell side to the buy side that investment decisions are really the only decisions in all of corporate america - from small business to wall street - that matters and by nature the decision experience is exceedingly personal. Put another way, if good capital allocation could be taught, we'd all be rich.  

To a novice, all of these factors add complexity to investment decisions. To a quantitative investor, they are noise from which a signal may bear fruit. To a fundamental investor, they are the background beat of the work. 

But to all forms of investors that try to differentiate themselves from the market, the investment decision is the most difficult aspect, even if Tom Petty says "the waiting is the hardest part". That's the second. 

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