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Invest Outside Your Boxed-in Brain: Take That 'Crazy' Gamble

Invest Outside Your Boxed-in Brain: Take That 'Crazy' Gamble
(Dollar Photo Club)

By    |   Friday, 21 July 2017 09:00 AM

The human brain is wired in an interesting way. We create shortcuts. Some are conscious, many are not. Consider a “fight or flight” response. It’s a situation that may come up from time to time, but it developed in an era when mankind lived in caves and had to go out hunting—sometimes being hunted themselves by other predators.

Our brain hasn’t quite evolved with the pace of society in the past few thousand years, let alone the past few decades. Considering the increasing complexity of the financial system, it’s amazing we can undertake intelligent decisions at all.

Today, we’re just as likely to fall prey to the dangers of our mental shortcuts—known as heuristics—than we are to benefit from them.

When thinking about finance, we’re often thinking about the future. Will a company’s next product be a hit or a flop? One of the most recurring errors I see in finance relates to those future projections.

Consider a company that’s been doing well and is growing at a rapid rate. Its products are in demand and are continuing to grow. It’d be nice to project increasing growth endlessly into the future, wouldn’t it? It sounds great, and it would man you’d just have to buy the stock now and expect it to go up. But that wouldn’t be accurate.

What if the product in question were Crocs (CROC) shoes? And what if this were 2006, when that was still a new, hot item? Projecting current growth into the future would have made no sense. Once everyone who wanted a pair of the rubber footwear had one, the growth was gone. It’s no surprise that the company went public during the mania, zoomed high, then crashed as sales fell off a cliff. But hey, at least they got to the publicly-traded phase of being a fad, unlike the pet rock.

Getting around these mental shortcuts can prove tough. It’s hard-wired into our brain from our caveman days. And where it isn’t hardwired in, we softwire it in. In 2008, I sat for the Level 1 CFA exam. That was a bad year to be talking about efficient markets. On multiple different days in October 2008 alone, stocks gyrated at levels that, statistically, should only occur once every 10,000 years.

Markets aren’t as efficient as we’re meant to believe. After all, the housing bubble got priced in somehow. Were markets being efficient then, or were our caveman brains simply seeing rising housing prices and acting accordingly without stopping to think about why they were going up so much, so fast? A few folks called it.

I wasn’t really one of them, but I also wasn’t finding the kind of valuations in the market that I want to see before investing. That kept me out of the worst of the decline. I was right to be out of the market, but not for the reason that became the most obvious in hindsight. That was fortunate, possibly even lucky. I still consider it an oversight on my part.

Mental indolence also leaves us unprepared for giant technological leaps. Our brains want to connect the dots from A to Z. The idea of going from A to B to Q is nearly incomprehensible.

It’s no surprise that tech stocks are the big winners in the markets. They’re the ones making disruptive changes to the status quo. The internet has upended (but not destroyed) centuries of physical creations from books to newspapers. Ride-sharing companies have destroyed the centuries-long taxi industry, a private-public sector endeavor where quantity was limited to keep prices high.

All these technological changes drive options and choices up, and costs down. That’s a good thing for society as a whole, even if it leaves some individuals worse off because of the changes. Even though change is truly the only constant in the universe, our brains have a challenging time with changes to the status quo.

Even knowing that, I have a difficult time with tech stocks as an investor. They don’t always fit into a growth box, and they hardly ever fit into a value box on the financials. Consider a company like Amazon (AMZN). 20 years ago, it was a humble book reseller on the internet. Today, it’s considered the big killer of the brick and mortar retail space. Yet they’re going into that space as well.

What has Amazon really done when you think about it? They’ve commoditized retail. It doesn’t matter if you buy a DVD from them or Best Buy (BBY). Both companies will price-match the other, offer free shipping, and basically forego big profit margins to make the sale. That’s why I see a future for retail that features Amazon and a competitor per category it operates in. The profit margins are too low for anything else, and a duopoly provides enough competition to prevent the huge potential profits of a monopoly.

It's hard to come up with one key idea when thinking about how our brains are ill-equipped to handle the complexity of today’s investment world. Thanks, brain.

If I had to pick one takeaway, however, it’d be that it’s important not to get boxed in. I’m a value guy at heart, but even I own shares of companies like Amazon (AMZN), Google (GOOG), and Apple (AAPL). It’s where the disruption is, and that can be hugely profitable. The future will hold a lot more in store for these companies.

Value still has its place, too though. And you can get better returns buying something out of favor… provided it eventually comes back into favor. I wouldn’t go hog-wild on anyone one trade, but I’d bet that some of the beaten-down names in retail will survive to compete with Amazon. Some of them may even come up with an idea or two you’d expect from a tech giant instead.

That’s part of the randomness of innovation. Embrace the randomness and think outside your own mental box. Be willing to invest in something you think is crazy, but could work out well from time to time. The results may surprise you.

Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and writes the monthly newsletter Crisis Point Investor.

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Embrace the randomness and think outside your own mental box. Be willing to invest in something you think is crazy, but could work out well from time to time. The results may surprise you.
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Friday, 21 July 2017 09:00 AM
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