Value Investing And Behavioral Finance
Success And failure
Parag Parikh explains why people fail at investing in the first few chapters. Then, he describes it by referring to human characteristics such as laziness, greed, self-interest, ignorance, etc. One of the main reasons for people's failure, as he explained, is their "unwillingness to delay gratification." Because of instant gratification, most people trade short-term gain for long-term pain.
Heuristics refers to the shortcuts that the brain employs when processing information. As a result, our brain does not process all of the information presented to it. This results in cognitive bias. Price to earnings heuristics, price to book value heuristics, and price to sales are some common valuation heuristics.
Certain universal principles do not change regardless of the circumstances, technological changes, geographical boundaries, demographic changes, and so on. The "Law of the Farm" is one such universal principle. You can't plant a seed today and harvest it tomorrow. The seed takes time to grow into a tree. It must go through various seasons. We will not be able to grow a tree in an instant. Nature does not provide us with immediate gratification.
If our lives are in tune with nature, we only naturally follow nature's laws. Success in life is determined by our ability to recognise that there are no shortcuts. If one takes such shortcuts, they are bound to fail.
The same is true for investments. Of course, you can't expect to make a quick buck by investing. However, most people today are attempting to invest in the hope of making a fortune.
Take a look around at the successful investors. They were successful because they could postpone gratification and understood the farm's law. Successful investors such as Warren Buffett, Charlie Munger, and Peter Lynch, to name a few, owe their success to their ability to avoid the "E" Factor.
The "E" Factor or "Expediency Factor," assumes that human nature is to solve problems with the least amount of extra-ordinary effort. This means that most people will choose the most convenient and easy path rather than the one that leads to success. Individuals who succumb to the Expediency Factor avoid obstacles and have the least impact on others. Every minute of every day, we fight a subconscious battle between doing what we know is right, difficult, and necessary and doing what is easy and of little value. The Expediency Factor isn't easily defeated, but there are examples all around you.
This understanding of human nature serves as the foundation for the various aspects of this book and will assist the investor in comprehending simplicity.
In terms of investing, it is simple, but the industry has made it complicated. It has woven a web of deception in its pursuit of instant gratification, complexity to perplex the investor; the same person on whom the industry is reliant on the government for survival. We, humans, are more concerned with concentrating, improving our intellect and, as a result, concentrating on developing the Intelligence Quotient (IQ). The most important balancing act, however, is the Emotional Quotient is a mechanism within us (EQ). We are all humans. We have both a mind and a heart. The mind controls our intellect. Our emotions are controlled by the heart.
A proper understanding and balance of the two lead to a successful life and a more fruitful and happy existence.
In his book "Emotional Intelligence," Daniel Goleman makes a strong case for the concept of Emotional Quotient (EQ). For example, parents want their children to attend the best schools possible. The motivation for such action is the belief that the environment, classmates, and teachers will help their children realise their true potential, allowing them to achieve great success when they grow up. The potential is frequently measured by high test scores and intelligent quotients (IQs). However, we often fail to understand whether IQ alone guarantees success or requires something else.
Take a look around you, and you'll notice that many people aren't exceptionally bright but are doing very well in terms of financial well-being and, more importantly, happiness. Yet, on the other hand, there are many people who, despite having a high IQ, perform poorly in life, end up stuck at the top of the corporate ladder, and fail to achieve a consistent dose of happiness and contentment. Understanding what scientists refer to as 'EQ' helps explain this anomaly.
What exactly is the Emotional Quotient?
Just as IQ is used to define a person's competence in terms of cognitive abilities, EQ is used to describe a person's mental composure. A person who can think clearly through life's challenges and accept failures without allowing them to demotivate him from moving forward is well-positioned to achieve success. Unfortunately, schools fail to develop this skill in children. It can, however, be cultivated by reflecting on our behaviour and the behaviour of those around us and observing how understanding and controlling emotions alone can help us realise our true potential.
This book is designed to shed light on various methods of developing one's EQ as a person and investor.