Financial guru James Montier on how to overcome bad investing habits
But don't get too optimistic, says James Montier, author of "The Little Book of Behavioral Investing: How Not to Be Your Own Worst Enemy" (Wiley). That's what got us in trouble the last time. Montier, who is a member of the asset allocation team at GMO, London, and a leading authority on behavioral investing, takes time to tell us how being a contrarian can be healthy for our bank accounts.
In today's market, what are investors doing wrong? How are we our worst investing enemies?
It is quite astounding; it appears that investors have learnt almost nothing from the experiences of 2008. They are acting as if it were all just a bad dream. Over-optimism is rife once again. There is little or no consideration of what might go wrong.
Over-optimism is probably the most common error I encounter on a regular basis. We human beings are an optimistic bunch. From an evolutionary point of view it makes a great deal of sense, cavemen won't have bothered taking on a woolly mammoth unless they were pretty optimistic, the pessimists would probably just have stayed at home in the cave.
However, we don't live in that environment any more, today over-optimism may well lead us astray (especially in financial markets).
You say don't trust the experts because they're paid to be positive and don't trust forecasting because it's all fake. So what can everyday investors trust?
Careful analysis and facts. Experts are generally far too confident in their advice, and are of course, paid to be positive (at least in finance). Forecasting is a mugs game. The idea that any of us know what the future holds is just supremely arrogant. So we need to stop pretending that we can divine the future, and instead concentrate on understanding the present, and preparing for the unknown. That's why we should invest with a margin of safety (buying an asset significantly below its intrinsic value) so that we are protecting against errors, mistakes and bad luck.
You describe three things that you look for when investing: valuation, balance sheets and capital discipline. Sounds easy enough. So why aren't we listening?
Warren Buffett correctly observes, "Investing is simple but not easy." The essence of investing really is simple. We are looking to buy cheap assets (A dollar for 50 cents, if you like). However, we have a whole range of emotions and biases that kick in to prevent us from following this simple path, hence the not easy part of Buffett's quotation.
Every expert I've talked to say one of the biggest mistakes investors make is they go into the market when things are too high, and sell when things are too low. So how can we get the timing right?
The answer is not to look at timing, but rather to look at valuations. For instance, I use a simple valuation measure, which Ben Graham suggested way back in the 1930s. I take the stock market price and divide it by earnings averaged over the last 10 years. Using this measure it is relatively easy to see when the market is massively expensive, and when it is cheap.
Of course, you also need to be a contrarian to benefit from this measure, because to buy when others are despondently selling, and sell when others are enthusiastically buying will be difficult. In general, there are three elements to being a successful contrarian. You need the courage to be different, you need an ability to be an independent thinker, and you need the grit and perseverance to stick to your principles. Those three traits don't come easily to most of us.
Your second to last chapter was very interesting: talking about process. Can you tease out the main points you want us to walk away with?
Sure, the main point that I think investors need to understand is that a focus on results is likely to lead you astray. The best way to maximize returns is to do the "right" thing over and over. This is where process comes in. While we can't control returns, we can control the process, by which I mean the way we approach investing.
As I mentioned earlier a whole gamut of biases tend to crop up in our behavior when it comes to investing. Many of the world's best investors have come up with ways to trying to protect themselves against these mental pitfalls, and enshrined them in the way that they go about investing (i.e. their process). So thinking about the mistakes you tend to make can lead to solutions, but these solutions must be hard coded into the way that you approach investing if you really want to avoid falling into the same mistake again.