Fires, Hubris and the Stock Market Investor

 |  Includes: FXI, PGJ
by: Roger Nusbaum

Sunday night at around 6pm, another volunteer firefighter and I responded to a call for an unattended fire that someone had going in a barrel. When we arrived, the owner was in the house and came out a few minutes later. I asked him to put out the fire, he asked me to cite an ordinance requiring him to do so and I said there was no ordinance - just that I was asking him to do so. We have had a fire going a few miles away that threatened an evacuation - point being, conditions for a fire are much worse than normal for November and this guy did not care.

Ultimately he declined my request on the basis that he knows what he's doing. Actually he does not know what he is doing, but there was no convincing him.

There is a parallel here to investing. The fire starter was way too overconfident in his knowledge and ability. Plenty of people are too overconfident in their investment knowledge and ability.

All of the quirky strategy ideas that I employ (and write about) are predicated on my being wrong and that I have more to learn.

To me, certain mistakes are forgivable and certain ones are not. The best example here is how much weighting goes to hot parts of the market. China is probably the hottest part of the market. While I don't own China anymore on a widespread basis, I would not fault anyone who does, even if it crashed tomorrow. Owning a possibly overheated sector that blows up is forgivable. Allocating 20% to such a segment after a monster run with the expectation that "I'll know when to get out" or "I can handle a dip" drifts into the realm of unforgivable.

Overconfidence leads to all sorts of problems in many aspects of life. I read signs of overconfidence in comments on the blog and commentary from other writers (fair enough for anyone to tell me that I am overconfident), and it is one of those things where there is no telling them, no saving them from themselves.

Investing can be very simple, especially when you manage your own money and there is no one you need to report to at quarter end. Just stay diversified and do not make big bets - that's it. If your idea about how to diversify produces a result below what you expect (some people don't need to keep up with the market, remember) for too long you need to make a change.

How do you diversify? Own all sectors, own other asset classes (not just stocks) and own foreign. You already know this. Have a simple game plan, have discipline to a strategy (I believe every strategy I have ever written about to be very simple) and just as important you need to buy a Trader's Almanac (or equivalent) so you understand how the market works.

Disclosure: I get no compensation, not even a free book, for repeatedly mentioning the Trader's Almanac.