Investment risk comes from not being mindful.

Investment risk comes from not being mindful.
31 March 2013

A lot of people have built their wealth by investing in the stock market. With returns of 12% to 18% per annum, or in the case of Netflix whose stocks gave a 735% return since October 9th 2007, stocks often provide a better long-term return on your money than savings or bonds.

Mindfulness is what sets the successful investor apart

Successful investors are mindful of the decisions they make and mindfully monitor their investments… in fact often successful investors are pre-occupied with failure rather than success. While people can be mindful about success, the irony is that pre-occupation on success tends to encourage simplification, reliance on the work of others (herd mentality), checklists and routines, this becomes mindlessness, characterized by reliance on past success and acting on “automatic pilot.”

Under the assumption that success demonstrates competence, people drift into complacency, inattention, and habituated routines. The mindful investor on the other hand focuses on the following five principals as laid out by Weick, Sutcliffe and Obstfeld in their research Organizing for high reliability:

Preoccupation with failure

Starbuck and Milliken’s (1988) analysis of the Challenger disaster points to the liabilities of success: “Success breeds confidence and fantasy.”

Nothing focuses the mind like the possibility of failure -- investors who are more aware about things going wrong are far less likely to lapse into a state of mindlessness, and far more likely to spot potential problems. 

 


Reluctance to simplify interpretations

Investors are defined by what they ignore, which means they are also defined by what can surprise them. Successful investors don’t simply lapse into default behaviors because that’s what they’ve always done, and they don’t simply rely on default methods of selecting stocks.

The preoccupation with failure will have given us learning experiences to ensure we continually examine our decision making process. A successful investor will seek out and carefully consider adverse opinions to ward off complacency and the confirmation bias.

Be sensitive to operations.

Sensitivity to operations reduces the incidence of surprises. Successful investors monitor their portfolio for things that are strange and when they uncover the mixed signals or hiccups they do not ignore them – rather they make a mindful effort to uncover what they mean in the overall context of the stock performance and long term potential impact.

Learn to be resilient.

Resilience is not only about bouncing back from errors; it is also about coping with surprises in the moment. Do you react at the smallest signal from the market or have the resilience to persevere with your decision?  Resilience helps us build ambivalence toward the applicability of past performance.

Resilience is also about recovering from failure – setbacks are part and parcel of life and they certainly show up in investing, by embracing setbacks we learn from them.

Don’t over-specify your decision structures.

Charlie Munger, the long-term partner of Warren Buffett says it is important to have mental models that we can rely on, but not one method. By bringing some fluidity into our decision process and avoiding prescriptive checklists and rule sets we can adapt to new information – and information is the key factor that has any meaningful impact on share price. We need flexibility to cope with the unexpected.

 

Following these 5 processes will help your investment strategy and remember mindfulness is as much about what you DO with the information you discover as it is about the activity of the discovery.

What processes do you follow for making investment decisions?

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Author
Head of Behavioral Finance
cashy
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