INVESTING WITH CLARITY® BLOG
Opportunity is Knocking…Answer the Door
May 30, 2019 10:14:53 AM
When people face an unclear situation, they tend to make a higher number of irrational decisions. This widely held premise that the more ambiguous the situation we face equates to a greater percentage of irrational decisions simply means that the less sure we are about the facts of the case, the more we worry about the consequences. Hence, not knowing the facts not only insights our fears, it also makes us void of the feeling that we are in control. If fear is generated by a lack of feeling in control and by a lack of knowledge, then would it not benefit us all greatly as to have a better grasp of the facts so as to aid us in making more rational decisions? Since investors are people, the same would hold true for individuals who put money to work in the capital markets. Hence, if as investors we simply knew what our actual holdings were, why we own these holdings and also understood the control over the investment process our Advisor had, would we not make decisions in a much more rational manner?
At Nepsis, we purport that investors make extremely poor trading decisions because they do not understand what lies at the core of their portfolios and because they have no sense of control over the process. Hence, investors become fearful when their account values drop and they prematurely sell perfectly sound businesses they own at discounted prices for fear of “losing more money.” On the other hand, when their account values rise, they buy more of what has appeared to have “worked” only to see afterwards that they paid inflated prices as they bought at the peak. This vicious cycle of buying high and selling low is exacerbated by the upside-down manner in which investors view price variability as they shun and fear what should be viewed as opportunity and latch-on to and welcome what should not. Thus, the process unfortunately works like this:
- Fear is the emotion emitted when a perceived risk is prevalent
- Fear is heightened when knowledge is suppressed and control is limited
- Investors operate from Fear because of limited knowledge and control
- Investors are told they should fear price swings because that is “Risk”
- We believe that Price Swings do not equal Risk and should not be feared
- Rather, Price Swings create Opportunities in both directions as they…
- Permit savvy investors to purchase companies on the cheap and they…
- Permit savvy investors to capture gains on companies selling at rich prices
The truth be told, Volatility is not risk, should not be feared but should be embraced and viewed as an ally. How can we say that you ask? If investors understood that price volatility can be used to their advantage in a disciplined process such as Strategic Cost Averaging to enhance returns they would not fear volatility but embrace it. Most investors do not understand their portfolio manager’s philosophy and strategy and simply do not know what holdings they own and why they own them. Because of this lack of knowledge and perception of not being in control they make irrational buy/sell decisions almost always at the worst possible time and thus erosion of returns settles in over the long term as the Dalbar Study suggests. At the end of the day, increased volatility simply creates a situation in which “opportunistic investors” who understand the inherent value of the companies they own and the process they control, can buy great businesses on the cheap and purge gains from great businesses that are temporally overprices. Hence greater volatility must be viewed through the lens of greater opportunity and should be welcomed and not shunned as the volatility of the stock market isn’t just something you have to put up with in order to earn superior returns; it’s actually an essential factor that directly improves your return. Opportunity is Knocking…Are you ready to Answer the Door?
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