5 principles of winning investing

Fresh off the glow of Toronto Raptors’ championship run, Mark Goodfield (aka The Blunt Bean Counter) finds five lessons for wannabe winning investors.

The Raptors are the toast of the town and the talk of the National Basketball Association. Fresh off a championship run that surprised some pundits, they now have basketball higher-ups wondering how to replicate their success.

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There are no ‘slam dunks’ in investing, but The Blunt Bean Counter finds five principles of winning investing drawn from the Toronto Raptors’ recent NBA championship run.

I’m more interested in the lessons investors can glean from the Raptors’ success—especially tips around the psychology of investing. Sports and investing mix hard analysis with emotion. We all know the role emotions play in sports. Less known are the psychological challenges of high-stakes investing. Researchers call them behavioural biases.

As Canadians continue to bask in the glow of Raptor success, here are five lessons investors can learn from this historic championship run.

#1: Herd mentality

The Raptors won a championship by going their own way. President Masai Ujiri set the tone with his bold acquisition of Kawhi Leonard who was recovering from injury and had played only nine games the previous season with the San Antonio Spurs. Coach Nick Nurse adapted the maverick approach to the hard-court, where he innovated on both offence and defence to help the Raptors win their first championship.

What investors can learn

Following the herd can be tempting as an investment strategy—popular stocks and funds often look like successful stocks and funds. In reality, smart investors take note of the investment climate but also stop to question the hysteria of the markets. Staying true to your investment policy and principles is important not only for picking stocks, mutual funds and exchange-traded funds, but also for timing decisions to buy and sell.

Avoiding the herd doesn’t need to push investors to the extremes of contrarian investing—but it does require independence and well-defined goals.

#2: Overconfidence

All athletes need to master that balance of confidence and overconfidence—avoiding the pull of ‘too high or too low’. The Raptors made a mantra of the practice, by preaching the benefits of ‘staying in the moment’. Because, when playing top-flight teams like the Golden State Warriors and Milwaukee Bucks, an overactive ego can prove as damaging as a faulty jump shot.

What investors can learn

What goes for athletes is also true for investors. So many investors think that a few smart investing moves will translate into long-term investing genius. In this way, overconfidence ties into a self-attribution bias, when investors believe their success can be attributed only to their investing acumen. If only investing were that straightforward. Even legendary investor Warren Buffett has made mistakes while wrestling with the limits of human intelligence and the inevitable factors beyond his control.

#3: Diversification

The Raptors present an interesting case of a superstar paired with a balanced team. While Kawhi Leonard proved pivotal to the team’s success, several Raptors contributed double-digit scoring. This led commentators to describe the Raptors as one of the more balanced championship teams in recent memory. The Raptors’ tendency towards balance only grew as the postseason progressed, and helped the team compensate for a Kawhi limited by injuries and opponents’ double-teaming defences.

What investors can learn

It may constitute almost the first rule of investing, but we tend to forget it: Diversify your holdings. Much as basketball teams can’t rely on scoring from one or two sources, investors can’t depend on big gains from a small number of similar investments. Portfolio risk needs to be spread among a variety of investment vehicles and various sectors.

Some investors fail to diversify due to a familiarity bias. The theory goes that people trust—and select investments based on—what they know best. They will therefore focus on domestic stocks and funds or those stocks and funds that are household names. By investing in international stocks, adding holdings in several sectors and including both low- and high-risk investments, investors put themselves in a better position. A word of caution: When exploring less familiar investments, seek out dependable research and advisors.

Familiarity bias can also be viewed as a home vs. international bias from an investing perspective.

#4: Worry

It’s not just sports fans that experience anxiety as they live and die with their teams’ fortunes. Even professional athletes have been known to lose sleep due to worry, as former Raptor Jonas Valančiūnas has acknowledged. When tired athletes bring the previous night’s restlessness to the court, their performance generally suffers. Raptors management recognizes this, and educates the players on how to use rest to prepare their bodies and minds for competition. This year’s edition of the Raptors was also helped by a coach, Nick Nurse, who cultivated a calming culture.

What investors can learn

Losing sleep may not directly influence investing performance in the same way as it drives on-the-court results. But researchers have uncovered interesting ties between worry and investing. Victor Ricciardi, who studies the psychology of investing, found that increased worry about a stock decreases an investor’s risk tolerance for that stock and the chances they will buy it. People may want to control their worries—but we all struggle to master our emotions around investing. For some, this can lead to sleepless nights, which can certainly impact us at the office and at home. Part of investing is matching our risk tolerance to our rest tolerance.

#5: Anchoring

Raptors fans may not know the anchoring bias by name, but they know it all the same. Years of seeing good teams bow out in the playoffs—sometimes in embarrassing fashion—conditioned fans to expect defeat for the team. Their beliefs about the future were ‘anchored’ in past Raptors performances. So much so, in fact, that one American sportswriter asked Raptors players about Torontonians’ so-called ‘defeatism’. Acquiring Kawhi Leonard helped shift fans’ perceptions, but many still found it difficult to believe this year would be different. Now a championship has given Raptors’ fans an entirely new, and positive, anchoring event to form their expectations in the future.

What investors can learn

Anchoring bias can unsettle our portfolios in surprising ways. The classic investing example concerns purchase price: investors hold on to a stock because they remember their purchase price, not the stock’s decrease in value. They use that original price as an anchor. On the other end of the spectrum, investors may exhibit an extremely low tolerance for risk based on past performance. Think of a new investor who lived through the record one-day TSX drop in 2008 and runs from the markets as a result. Even the investing styles of our parents can anchor our perceptions of the correct way to invest.

Anchoring, like all investing biases, is difficult to avoid. Even our best attempts at fully rational investing behaviour can’t rid us of the emotions that make us human. What we can do is become aware of our personal biases, understand why they may exist, and access the best research and professional advice possible so that facts and data inform our investing decisions. And be sure to ask questions; even advisors have their investing biases. Professional advisors should be able to explain their investing recommendations to you.

This article provides general information on various matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisor.

This is an edited version of an article that was originally published for subscribers in the July 2019 issue of The Taxletter. You can profit from the award-winning advice subscribers receive regularly in The Taxletter.

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