Photo: Igor Ovsyannykov. Source: Fancycrave
Everyone looks at the world through their own particular lenses: we’re limited by our own minds. We can never see anything truly objectively; we only know what we think we see. What we have are different shades of rose-colored glasses.
This is a problem for investors. We tend to search for, interpret, favor, and recall information that confirms our preexisting beliefs. We call this “confirmation bias,” and it feeds our overconfidence. Suppose I think Coca-Cola is a great company and a stock worth buying. I will focus on its long-term return, its steady and growing dividend, its global revenue stream, its stable credit rating. But if I don’t like the stock, I’ll note its elevated PE ratio, its lackluster financial performance, its inability to diversify its product line, and their byzantine management structure. In other words, there’s lots to like or dislike on both sides of the issue.
If I buy Coke shares and they go up, I’ll tend to remember that; if they go down, well, you can’t win them all. Ditto if I sell them. Our tinted lenses paint the world in the way that we want to see it. We’re entangled with the facts that we’re trying to study. But there is a reality out there outside of the particular view we have of the world—and eventually, that reality bites.
That’s why it’s important to keep records and examine our thinking on a regular basis. In a diversified portfolio, there will always be dogs and darlings. Some selections make us feel like geniuses; others will prompt us to ask, “What were we thinking?” Diversification is the compliment that humility pays to uncertainty. We don’t know the future; a lot of time, we don’t know the present or even the past. So we want to invest in different types of asset classes in different industries up and down the capital structure—some with senior claims on cash flow, some with operational claims, some with residual claims. Noting that it rarely pays to overpay.
We can’t take off the glasses that we use to see the world. But we can recognize our own limitations.
Douglas R. Tengdin, CFA
Charter Trust Company
“The Best Trust Company in New England”