Monday, August 31, 2009

Think Today

One of the most common mistakes investors make is living in the past. It is essential to think today, not yesterday and not tomorrow. This is not to say we don’t utilize information from yesterday and make forecasts about tomorrow, but more to point to the internal biases we develop and maintain that interfere with rational evaluation of the current situation, e.g. I can’t sell that stock, it’s has too large a gain, it belonged to my father, it was the company that made our fortune, it’s a part of the family, it’s gone down so much surely it will bounce back, it’s blue chip it must be safe, and so on.

In the meltdown of 2008, a host of wealthy investors lost fortunes in bank stocks. Many of them were holding shares that had resulted from mergers which completely changed the operating metrics of the original holding company. The industry had changed, the management had changed, the risk of the business had changed but the names were not changed, just everything relevant to the value of the business. So why did so many people hold onto these time bombs? I suspect it was not because they were “thinking today”.

Issues of leverage and asset concentration were a major contributor to bank stocks demise. The departure from traditional banking practices and entry into derivatives and other extremely complex securities compounded those issues. What people remembered or thought they owned was in fact not at all what they owned—they weren’t thinking today, but thinking yesterday.

Thinking today does not mean adopting a trading mentality but rather recognizing the moment, the situation you are in, and its context. The people who hold concentrated positions are making a decision of great importance whether or not they choose to think about it today. Holders of concentrated positions are making a probability assessment of market value. They also usually underestimate the consequences of their assessment. In Atlanta I know the failure or near failure of two different companies cost our community well over a billion dollars in market value. The true consequences of the losses are still vastly misunderstood—both by the losers and their observers. Those that do understand are mad as hornets about the recent admissions by Hank Paulsen—but that’s a blog for another day.

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