In the first four parts of this article, I have discussed a number of well-known behavioral biases that cause investors to make decisions that are, to put it kindly, less than optimal. In this final installment, I summarize how best to avoid these costly traps.
As these blog posts have been published over the past couple of weeks, the issues are much in evidence. Apple (AAPL), long the darling of the market, has lost favor and Groupon (GRPN) seems to be following a relentless downward spiral. Surely many investors in Groupon must be asking themselves how they could possibly have seen the company as a good bet. Apple stock, which was trading at $700 in mid-September, is currently at $544, a decline of 22% in two months. The news that has come out on Apple does not seem sufficient to justify such a broad shift in the market’s consensus as to the long-term value of Apple as a company. And, of course, we have the poster child of behavioral bias: Facebook (FB). How is it possible that the market’s consensus view of the share value of such a widely held company could be almost 50% below its first day closing price of $38? As Warren Buffett is quoted as saying, in the short-term the market is a voting machine and in the long-term the market is a weighing machine. When voting overwhelms weighing, investor psychology is dominating.
In the academic finance world, it’s fairly common to find comparisons of investors to gamblers and certain types of stocks have been referred to as ‘lottery tickets.’ I’ve found that this comparison is actually quite important. There is an odd paradox between the assumption that investors are rational when it comes to investing, yet still spend an awful lot of money playing the lottery. When we speak of “lottery ticket” investments, we are talking about investments that have a small probability of a big “win” and a large probability of a modest “loss.” And this is precisely the situation with lotteries.
The reality is that people spend considerable sums of money on lottery tickets, a money gamble that has a negative expected value. This same appeal (big, low-probability win, modest high-probability loss) also seems to motivate some investors. Continue reading →
Facebook recently filed for an initial public offering (IPO) to raise $5 billion in its IPO, putting its total valuation at $100 billion. Many investors, both institutional and individual, are drooling over the prospects of buying into the hottest company on the block – for now.
I say for now, because other investors are questioning how profitable the social network is, how fast revenues are growing, and whether the company is worth a $5 billion valuation. (It will be three times more expensive than Google was at its IPO).
Thus the question: should the typical Joe Investor consider investing in Facebook or any other hot company? Continue reading →
The article suggests that the traditional process of seeking employment or demonstrating your work history and capabilities, (a.k.a. the résumé), is becoming far less relevant. Now anyone who cares about your work experience or professional accomplishments, can simply Google your name and find out for themselves. Continue reading →