{"id":9530,"date":"2014-08-08T16:19:48","date_gmt":"2014-08-08T10:49:48","guid":{"rendered":"https:\/\/www.moneyworks4me.com\/investmentshastra\/?p=9530"},"modified":"2020-03-04T14:50:50","modified_gmt":"2020-03-04T09:20:50","slug":"too-good-to-be-true","status":"publish","type":"post","link":"https:\/\/www.moneyworks4me.com\/investmentshastra\/too-good-to-be-true\/","title":{"rendered":"Too good to be true?"},"content":{"rendered":"

In the fifth article of our Series on \u2018The Most Important Thing\u2019, we show you why if a certain investment is too good to be true, it probably is\u2026<\/p>\n

Time and time again, the post-mortems of financial debacles include two classic phrases: \u201cIt was too good to be true\u201d and \u201cWhat were they thinking?\u201d<\/p>\n

Why do we investors keep making such mistakes repeatedly? Because investing is an action undertaken by human beings, most of who are at the mercy of their psyches and emotions. According to Marks, there are four important emotions that govern our behaviour:<\/p>\n

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  1. Greed<\/strong>: <\/span>The first emotion that serves to undermine investors\u2019 efforts is the desire for money, especially as it transforms into greed. Most people invest to make money. There\u2019s nothing wrong with trying to make money. Indeed, the desire for gain is one of the most important elements in the workings of the market and the overall economy. The danger comes when it moves on further to greed. Greed is an extremely powerful force. It\u2019s strong enough to overcome common sense, risk aversion, caution, logic & all the other elements that might otherwise keep investors out of trouble.<\/li>\n
  2. Fear<\/strong>:<\/span> In the investment world the term doesn\u2019t mean logical, sensible risk aversion. Rather, fear\u2014 like greed\u2014 connotes excess. Fear is overdone concern that prevents us from taking constructive action when we should.<\/li>\n
  3. Tendency to dismiss logic, history and time-honoured norms<\/strong>:<\/span> This tendency makes us accept unlikely propositions that have the potential to make us rich<\/li>\n
  4. Following the herd<\/strong>:<\/span> Participating in the extremes of cycles can be dangerous for our financial health<\/li>\n
  5. Envy<\/strong>:<\/span> We might be perfectly happy with our lot in isolation but become miserable when we see others do better. In the world of investing, most people find it terribly hard to sit by and watch while others make more money than they do.<\/li>\n
  6. Ego<\/strong>:<\/span> The best returns bring the greatest ego rewards. When things go right, it\u2019s fun to feel smart and have others agree<\/li>\n
  7. Capitulation<\/strong><\/span>: Investors hold to their convictions as long as they can, but when the economic and psychological pressures become irresistible, they surrender and jump on the bandwagon<\/li>\n<\/ol>\n

    To avoid losing money in bubbles, the key lies in refusing to join in when greed and human error cause positives to be wildly overrated and negatives to be ignored.<\/strong><\/span><\/h3>\n

    When a market, an individual or an investment technique produces impressive returns for a while, it generally attracts excessive (and unquestioning) devotion, thus seeming to become the \u201csilver bullet\u201d. But the silver bullet doesn\u2019t exist. No strategy can produce high rates of return without risk. And nobody has all the answers; we\u2019re all just human. Markets are highly dynamic, and, among other things, they function over time to take away the opportunity for unusual profits. Unskeptical belief that the silver bullet is at hand eventually leads to capital punishment<\/p>\n

    Every time a bubble bursts, a bull market collapses or a silver bullet fails to work, we hear people bemoan their error. The skeptic, highly aware of<\/strong> that, tries to identify delusions ahead of time and avoid falling into line with the crowd in accepting them<\/strong>. So, usually, investment skepticism is associated with rejecting investment fads, bull market manias and Ponzi schemes.<\/p>\n

    In dealing with the future, we must think about two things: (a) what might happen and (b) the probability that it will happen.<\/p>\n

    The process of investing requires a strong dose of disbelief. . . . Inadequate skepticism contributes to investment losses. But Skepticism and pessimism aren\u2019t synonymous. Skepticism calls for pessimism when optimism is excessive. But it also calls for optimism when pessimism is excessive.<\/strong><\/p>\n

    The error is clear. The herd applies optimism at the top and pessimism at the bottom. Thus, to benefit, we must be skeptical of the optimism that thrives at the top, and skeptical of the pessimism that prevails at the bottom.<\/p>\n

    Whenever the market collapses, for example, most people say, \u201cWe\u2019re not going to try to catch a falling knife; it\u2019s too dangerous.\u201d They usually add, \u201cWe\u2019re going to wait until the dust settles and the uncertainty is resolved.\u201d What they mean, of course, is that they\u2019re frightened and unsure of what to do. The one thing I\u2019m sure of is that by the time the knife has stopped falling, the dust has settled and the uncertainty has been resolved, there\u2019ll be no great bargains left.<\/strong><\/p>\n

    It\u2019s our job as contrarians to catch falling knives, hopefully with care and skill. That\u2019s why the concept of intrinsic value is so important.<\/p>\n

    The process of intelligently building our portfolio consists of buying the best investments, making room for them by selling lesser ones, and staying clear of the worst. The raw materials for the process consist of (a) a list of potential investments, (b) estimates of their intrinsic value, (c) a sense for how their prices compare with their intrinsic value, and (d) an understanding of the risks involved in each, and of the effect their inclusion would have on the portfolio being assembled.<\/p>\n

    But what is it that makes something the superior investment we look for? As mentioned in our previous Blog, it\u2019s largely a matter of price. Our goal isn\u2019t to find good assets, but good buys. Thus, it\u2019s not what you buy; it\u2019s what you pay for it!<\/strong><\/p>\n

    So the goal is clear – find under-priced assets. But where should we look for them?<\/p>\n

    Marks\u2019 gives us a good idea of where to start by asking us to look among things that are:<\/p>\n