Few people are aware that Albert Einstein put a significant portion of his Nobel Prize money in stock markets in 1921. However, he lost most of it in the 1929 stock market collapse. He is not, however, to fault. Because back then, investment didn't need any qualitative assessments. What Einstein failed to see is that there is no secret formula for finding low-cost stocks. However, the tendency to purchase only when others are afraid is a behavioral feature. Now, 1929 was not the first occasion when investors had a bad time with the stock market. Even as late as 2007, however, little lessons had been learned.
Wall Street analysts utilized complicated formulas to explore how previous performance might be used to predict future outcomes. They ran screens, tried situations, and compared their results to peers' standard deviations. It seemed easy to them to be impartial in their investment selections. With a single basis point adjustment in price, they could anticipate the tiniest change in the company's earning ability. However, they were unconcerned about the predatory pricing of subprime mortgages. They 'objectively' invested and reinvested in zero-value collateralized documents.
This was solely motivated by their desire for a larger return on investment. When the loans went bad and the banks were on the brink of going bankrupt, the objectivity of such investment was called into doubt. Because investing is commonly regarded as a science, objective assumptions should provide accurate results. However, as any scientist will tell you, even in separating distinct parts of a molecule, the subjective element is required.
Many of today's best scientists equate cutting-edge research to fine art. Investing behavior, no matter how reasonable, cannot be stereotyped. Online trading, in other words, cannot be standardized or mechanized. A certain amount of subjectivity is required. If you will, call it the human factor. Despite being a stickler for data, Benjamin Graham allowed ample room for behavioral decision-making. The idea of the margin of safety,' which he popularized in his book, is an example of this.
Seth Klarman, a leading value investor, describes value investing as "the union of a contrarian streak with a calculator." Contrary to popular belief, not all value investment is contrarian. Aswath Damodaran, a valuation specialist, has divided value investors into three groups:
- 'Contrarians,' who hunt for value in the most overvalued companies in the hopes of seeing prices return to the mean.
- 'Screeners,' or those who seek for companies that have lower valuation multiples than their closest counterparts.
- 'Activists' who buy big interests in firms that are cheap or badly managed in the hopes of unlocking shareholder value.
Aside from the arithmetic, you'll note that each of these techniques has a behavioral component. As a result, even if you are as brilliant in the latter as Einstein, disregarding the behavioral side of investing would not help you. You might be well-known but not wealthy.
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