You Don’t Have To Be Super-Smart To Get Rich

By ShareInvestor

What matters is to ensure your emotions don't affect investment decision-making process

As a long-time financial reporter, I know plenty of millionaires who struck it rich through businesses they had started - yet despite their success, they were certainly not among the smartest people I knew.

In fact, some of the brightest people I have ever met go all the way back to my undergraduate days in England nearly 40 years ago - researchers who spent their lives solving complicated physics and mathematics problems.

They were extremely knowledgeable, but they were far from rich. Some were also not very good at their own personal finances.

They reminded me of the great 17th-century scientist Isaac Newton, who lost his entire life savings - a princely sum equivalent to £3 million (S$5.4 million) in today's terms - in a stock market bubble. That was despite his having one of the keenest minds in history, making astonishing discoveries that continue to have a big scientific impact today.

It leads me to that question that crops up once in a while: If these people are so smart, why aren't they rich?

Newton had no doubts as to where he had gone wrong, as he ruefully observed that he could calculate the movements of stars but was unable to comprehend the madness of men.

It is a tacit acknowledgement that the crowd psychology, which is responsible for wild swings in stock prices, can sometimes be a lot tougher to fathom than the laws of physics, which he did so much to unravel.

In his book, Street Smarts, financial guru Jim Rogers offers another startling example of how a person can end up going broke even though he is smart.

As a young man, he had shorted the shares of six different companies, anticipating that their share prices would fall. But two months after doing so, his savings were completely wiped out as the shares continued to rise.

"I had been forced to keep covering my shorts because I did not have sufficient holdings in my brokerage account to hang on until the prices started to fall. I did not have the staying power that short-selling requires," he admitted.

What was interesting was that two or three years after that, each of the six companies he had shorted had gone bankrupt. That, he noted, was a perfect example of being smart and not being rich. "I had been so smart I went broke. I did not know what the markets were capable of," he said.

It harks back to an observation supposedly made by the great economist John Maynard Keynes that markets can stay irrational longer than you can stay solvent.

However, I suspect the problem many of us encounter as investors is quite the opposite of what Mr Rogers had experienced.

There are times when we come across a great counter to invest in, but because its share price has already run up sharply, we hesitate to buy into it and wonder if we should wait for a correction. Then as its price runs up further, we give up the chase altogether.

That is why I find the great fund manager Peter Lynch's observation so valid. He said: "Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in the corrections themselves."

Still, interesting though these observations are, they will merely stay as observations if not for the work of Professor Richard Thaler, the winner of this year's Nobel Prize for economics, and others in the field of behavioural economics.

What Prof Thaler demonstrates through his research is that when we make economic, financial and investment decisions, we do so as flawed humans with a tendency to do the wrong thing - even if we possess the brilliant intellect of Newton or Keynes.

And recognising this flaw in us is the first step towards changing our investment behaviour for the better - that many of the inherent traits that have evolved over the millennia to help us to survive as human beings actually make us bad investors.

For instance, Prof Thaler shows that one of the more important biases that influence our investing behaviour is "loss aversion".

That is because, for many of us, the pain of losing money is around twice as intense as our enjoyment of making it.

That goes some way towards explaining my earlier observation as to why we are so hesitant about ploughing our money into a stock that has already enjoyed a great run-up, namely, the fear that there may be a sudden price correction after that.

It explains why so much money is still parked in cash and other perceived safe havens such as government bonds which offer next to nothing in returns, even though the stock market has been enjoying a bull run for the past nine years following the global financial crisis.

Confirmation bias is another important behaviour trait that can prevent us from making sensible investment decisions. We seek safety in whatever we invest in by seeking out information which lends support to the idea that our investment decision is right.

For many people, that can mean loading up on the stocks that some prominent investment experts also piled into. The reasoning goes that since they are big buyers in a certain counter, you should also be a buyer yourself. However, blindly following experts may be the worst possible reason for buying into a stock.

These investors have the ability to take any investment mistake in their stride because they have plenty of money in the bank. But it is a luxury you may not be able to afford.

There is one other interesting human trait Prof Thaler has been able to use in nudging people towards making better investment decisions.

In physics, Newton had observed that a stationary object will continue to remain absolutely still unless it is disturbed by some external forces.

In everyday life, we know it as the tendency to keep things as they are unless we are forced by circumstances to make changes. We call it financial inertia.

So on an important subject such as retirement saving, most of us know that we need to do more.

But the truth is that apart from our Central Provident Fund contributions, few of us really bother to sock away a sum each month and try to invest it to maximise the returns. It is just too much of a hassle for most people.

In the United States, Prof Thaler helped to devise a programme, Save More Tomorrow, that nudges employees into saving more by automatically putting them into a pension scheme known as the 401(k).

In other words, rather than have to sign up, a person must choose not to be in the scheme.

The result is that owing to financial inertia, most decided to stay and put money into the 401(k) accounts established for them. That would greatly improve their quality of life when they later retire.

We have a similar plan here - the Supplementary Retirement Scheme (SRS) - which complements the CPF by helping Singaporeans to save for their retirement by offering them tax breaks on the money squirrelled away.

I sometimes wonder if a programme similar to Prof Thaler's Save More Tomorrow would improve the take-up rate for the SRS scheme.

There are lots of grand theories about what moves markets and money. But at the end of the day, what really matters is how to control our emotions and ensure that they do not affect our investment decision-making process.

You don't have to be super-smart in order to be rich.

"This article "You Don't Have To Be Super-Smart To Get Rich" by Goh Eng Yeow was first published in The Straits Times on 29 Oct 2017 and is reproduced in this blog in its entirety."

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