The Laws of Wealth book summary
Summary
TLDRThe video script delves into the behavioral risks in investing, highlighting how our emotions and irrational biases can impede sound financial decisions. It emphasizes the importance of humility in assessing abilities, the influence of emotions on decision-making, and the value of seeking advice from financial advisors. The script also advises against panic reactions to market fluctuations, scrutinizing company management actions over words, and choosing value over glamour in stock investments. It concludes by advocating for aligning investments with personal goals and the simplicity of following a few key rules for successful investing.
Takeaways
- đ Behavioral Risk: Investors often overlook the impact of their own behavior on investment decisions, which can be influenced by emotions and irrational thinking.
- đ§ Overconfidence Bias: Many people, including investors, tend to overestimate their abilities, which can lead to fundamental attribution errors and hinder learning from mistakes.
- đ Emotional Impact: Strong emotions, both positive and negative, can impair decision-making abilities in investing, as demonstrated by various psychological studies.
- đ€ Value of an Advisor: Hiring an investment advisor can significantly improve decision-making and financial outcomes, especially during market crises.
- đĄ Importance of Humility: Recognizing and addressing personal limitations and being open to learning from mistakes are crucial for becoming a good investor.
- đ« Avoiding Panic: Investors should not react impulsively to market fluctuations or sensational news, as these reactions can lead to poor investment decisions.
- đ Evaluating Actions Over Words: When assessing a company's leadership, it's more effective to observe their actions, particularly their investment decisions, rather than relying on their statements.
- đ° Investing in Value: Rather than being swayed by the allure of high-priced glamour stocks, investors should focus on value stocks that offer better growth potential and lower risk.
- đ· Caution with Novel Investments: The excitement around new and exotic investments can lead to irrational exuberance and poor investment choices, as seen in historical market bubbles.
- đ Aligning with Personal Goals: Investors should tailor their investment strategies to their own financial goals and values, rather than blindly following others' advice or rules.
- đ Simplifying Investment Strategy: By adhering to a few key principles and avoiding unnecessary complexity, even novice investors can make sound investment decisions.
Q & A
What is the concept of 'behavioral risk' in investing as discussed in the script?
-Behavioral risk in investing refers to the vulnerabilities and irrational behaviors of the investor themselves, which can negatively impact investment decisions. It includes factors like overconfidence, emotional reactions, and the tendency to make decisions based on feelings rather than rational analysis.
Why is overconfidence considered a bias in the context of investing?
-Overconfidence bias is considered a problem in investing because it leads individuals to believe they have superior abilities or insights compared to others. This can result in taking excessive risks, disregarding potential losses as circumstantial, and failing to learn from mistakes, which hinders growth as an investor.
What is a 'fundamental attribution error' and how does it relate to investing?
-A fundamental attribution error is a psychological phenomenon where people tend to attribute their successes to internal factors, like their own talent or skills, while blaming external circumstances for their failures. In investing, this error can prevent individuals from learning from their losses and improving their investment strategies.
How can emotions affect an investor's decision-making process?
-Emotions can significantly impair an investor's ability to make rational decisions. Extreme emotional states, whether positive or negative, can lead to impulsive actions, such as making reckless investments when excited or panic selling during market dips when feeling fear or sadness.
What role does an investment advisor play in helping investors make better decisions?
-An investment advisor provides critical support to investors by offering professional advice, helping them stick to their investment plans, and making more informed decisions. They can also act as behavioral coaches, helping investors manage their emotions and avoid making decisions based on temporary feelings.
Why is it important for investors to not overreact to market dips?
-Market dips are a normal part of the investment cycle and typically do not affect the long-term value of a stock portfolio. Overreacting to dips by selling stocks immediately can result in losses, as it is usually wiser to hold onto stocks with the expectation that their value will recover over time.
How can evaluating a company's management actions help investors avoid falling prey to fraudulent schemes?
-By observing the actions of a company's management, particularly how they invest their own money, investors can gain insights into the company's health and integrity. Insider buying can be a strong indicator of confidence in the company's future, whereas selling by insiders might signal underlying issues.
What is the significance of investing in value stocks over glamour stocks?
-Value stocks are often less popular but offer greater potential for growth and are typically purchased at a fair price, making the investment less risky. Glamour stocks, while attractive due to their rapid rise in value, can be overpriced and risky, especially when bought at the peak of their popularity.
Why should investors be cautious about investing in novel and exotic investments?
-Novel and exotic investments can be highly attractive due to their novelty and potential for high returns. However, they often come with greater risks and may not have a proven track record. Investors should be wary of being seduced by the allure of such investments without thoroughly assessing their substance and long-term viability.
How can aligning investments with personal goals and values help investors maintain a clear perspective?
-Aligning investments with personal goals and values ensures that the investor's decisions are consistent with their long-term aspirations and needs. This clarity can help investors remain focused and avoid being swayed by market fluctuations or short-term temptations.
What is the advice given for new investors who feel overwhelmed by the amount of advice available on investing?
-The script suggests that new investors should learn a few simple rules and ignore the rest of the advice. By focusing on key principles, such as not overreacting to market dips and investing in value stocks, novice investors can develop a solid foundation for making informed investment decisions.
Outlines
đ€ Behavioral Risks in Investing
The first paragraph addresses the psychological aspects of investing, emphasizing the concept of 'behavioral risk'âthe idea that investors' own actions and emotions can pose significant risks to their investments. It points out that while investors are often aware of market risks, they may overlook the impact of their own irrational behavior. The paragraph discusses overconfidence bias, where people tend to overestimate their abilities, and how this can lead to poor investment decisions. It also touches on the importance of recognizing and learning from mistakes, as well as the influence of emotions on decision-making, using examples from social psychology experiments to illustrate the point.
đ The Impact of Emotions and Advisors on Investment Decisions
This paragraph delves into the effects of emotions on investment choices, highlighting how both positive and negative emotional states can impair decision-making abilities. It references studies that show how strong emotions can lead to reckless behavior, drawing parallels to investment scenarios. The paragraph also underscores the value of having an investment advisor, who can provide critical support and help investors make better decisions, especially during market crises. It discusses the benefits of advisors in terms of financial yields and their role as behavioral coaches, offering a reality check against emotional decisions.
đ« Avoiding Panic and Dodgy Companies in Investments
The third paragraph warns against the dangers of panic in the face of negative news about investments, such as company fraud investigations. It explains the human tendency to catastrophize and how this can lead to rash decisions based on fear. The paragraph advises investors to look beyond what company executives say and focus on their actions, particularly their investment in their own company's stock. It suggests that insider buying patterns can be a strong indicator of a company's potential, and it cautions against the allure of high-priced glamour stocks, advocating for value investing instead.
đ· The Perils of Novel and Exotic Investments
This paragraph discusses the historical allure of novel and exotic investments, using the example of the tulip mania in the 1600s to illustrate the dangers of speculative bubbles. It draws a parallel to modern examples, such as the dot-com bubble, to highlight how excitement for new and innovative ventures can lead to irrational investment decisions. The paragraph advises investors to be wary of such enthusiasm and to make rational assessments based on a company's substance rather than its allure.
đŻ Aligning Investments with Personal Goals
The fifth paragraph emphasizes the importance of aligning investment strategies with personal financial goals and values. It suggests that investors should determine their own benchmarks for financial security and use these to inform their investment choices. The paragraph also discusses the power of language in shaping financial behavior, suggesting that explicitly naming the purposes of savings and investments can motivate better financial habits. It concludes by advising investors to focus on a few simple rules and to ignore the overwhelming amount of advice available, advocating for a systematic approach to investing based on personal needs and values.
Mindmap
Keywords
đĄBehavioral Risk
đĄOverconfidence Bias
đĄEmotional Decision-Making
đĄInvestment Advisor
đĄFundamental Attribution Error
đĄCatastrophizing
đĄInsider Buying
đĄValue Stocks
đĄGlamour Stocks
đĄNovel and Exotic Investments
đĄPersonal Financial Goals
Highlights
Investors often overlook the behavioral risk that stems from their own vulnerabilities.
Behavioral risk includes irrational behaviors and emotional responses that can affect investment decisions.
Overconfidence bias can lead to an inflated sense of one's abilities and hinder learning from mistakes in investing.
Emotions can significantly impact investment decision-making, with both positive and negative emotions potentially leading to reckless choices.
Hiring an investment advisor can provide critical support and help investors make better decisions.
Advisors can act as behavioral coaches, assisting investors in managing their emotional responses to market changes.
Investors should avoid making decisions based on panic, as market corrections are normal and not always indicative of long-term issues.
Evaluating a company's management by their actions, not their words, can provide insight into the company's health and investment potential.
Insider buying patterns can be a strong indicator of a company's potential for growth and success.
Investors should be cautious of the allure of high-priced 'glamour stocks' and instead focus on value stocks with room for growth.
The historical tulip mania serves as a cautionary tale against investing in novel and exotic assets without due diligence.
Investors should align their investment strategies with their personal financial goals and values.
Labeling savings and investments with specific goals can motivate individuals to save more effectively.
Learning a few simple investment rules and ignoring the rest can help investors avoid becoming overwhelmed by advice.
Investors should not overreact to market dips and should focus on purchasing value stocks instead of glamour stocks.
Transcripts
daniel crosby
the laws of wealth
psychology and the secret to investing
success
when you invest in stocks you're always
weighing up risks against a possible
return
but what if there is a whole area of
risk that you're not aware even exists
investors are used to being cautious
about the risks of the market as a whole
such as a stock market crash or the
health of a particular company
but one of the greatest risks to our
investments comes not from the stock
market but from ourselves
behavioral risk or the vulnerabilities
of the investor herself is one of the
key factors to grapple with when
investing
like it or not we are irrational we get
overwhelmed by information and can
become panicky or over emotional
while we may fancy ourselves intuitive
and astute our judgment can be clouded
by slick sales pitches and clever
one
we overestimate our abilities in life
and when we invest
from an early age it's drilled into us
that we should think positively and have
confidence in ourselves and our skills
but what if that confidence is actually
holding us back
in one revealing study american high
school students were asked about how
they thought their math skills compared
to those of the rest of the world
a vast majority assumed that they were
some of the best internationally
the truth is that american students are
average at math
this is an example of overconfidence
bias
that is people assume incorrectly that
they perform in a manner that is
superior to other people
in a similar vein organizational
researchers tom peters and robert
waterman conducted a study in which they
asked employees to compare themselves to
each other and rate themselves on such
qualities as interpersonal skills and
physique
one hundred percent of the respondents
thought that they were better than
average at interacting with other people
ninety-four percent believed that their
athletic prowess outranked that of their
peers
not everyone they interviewed could have
been a master of diplomacy with a
bodybuilder's physique
evidently the respondents overestimated
themselves
but what can a little self-confidence
hurt
even if it's misplaced
isn't it better than being horribly
insecure
well when it comes to investing having
an inaccurate view of your abilities can
hurt very much
if you believe that you have exceptional
abilities you will likely credit any
wins on the stock market to your unique
talent
however you'll believe that any losses
are circumstantial and out of your
control
that is called a fundamental attribution
error
it states that we're unable to judge the
effects of our actions accurately
this perspective keeps you from learning
from your mistakes and growing as an
investor
you may think that the roles of the
stock market don't apply to you
that can lead you to disregard risk and
make reckless decisions because you're
so confident in your instincts
you might also be less likely to seek
outside help from a trusted advisor
being humble about your abilities and
being able to identify and learn from
your mistakes are key to becoming a good
investor
two
our emotions can affect our ability to
make good decisions
who doesn't love sobbing while watching
a sad movie or feeling excitement
flooding through your body when falling
in love
extreme emotional states make life
interesting
however when it comes to investing
extreme emotions can impede your
decision-making skills
in an experiment conducted by social
psychologist jennifer lerner
participants were divided into two
groups
one group was instructed to watch a
scene from a sad movie and then write
about it
the other group was given a short boring
video clip about fish to watch
afterward they were asked to write about
their daily activities
the researchers then conducted a second
behavioral experiment in which they
asked the same participants to pretend
that they were selling and buying pens
they found a marked correlation between
good decision-making and a lack of
strong emotion
sellers in the group that watched the
boring movie were much shrewder when
deciding how much they should sell their
pens for
overall they charged 33 more than the
group that watched the sad movie
so a sad investor is potentially a
gullible investor but what about
positive emotions like excitement
in his 2009 book predictably irrational
the hidden forces that shape our
decisions
behavioral economist dan ayerly
published the results of an experiment
designed to assess the effect of
excitement on decision-making
he interviewed a group of students about
their sexual practices asking questions
like
would you cheat on a partner and would
you have sex without a condom
when first asked these questions most
students answered both with no
the researchers then showed the same
group of students some pornographic
images
they then repeated the same questions
with some surprising results
students answers reflected that they
would be 136 percent more likely to
cheat on a partner and 25 percent more
likely to have unprotected sex than
before they had viewed the images
feeling passion and excitement had made
these students much more reckless
they knew perfectly well that their
behavior was irresponsible but in the
heat of the moment they weren't able to
practice restraint
the parallels with investing are obvious
of course investing is not like watching
porn however making nail-biting deals
involving such high personal stakes can
also elicit strong emotions
as we have seen both positive and
negative emotions can affect your
decision-making abilities
but how do we learn to keep our cool and
make rational decisions
one of the best ways is to get an
investment advisor
three
one of the best investing decisions you
can make is to get an advisor
investors may have all the rules in
their heads they may have read a zillion
books and learned that they need to plan
carefully and avoid impulse buying
however knowing is not enough
this is why hiring an advisor is
essential
research has shown that advisors have a
critical influence on helping investors
make better decisions and stick to the
investment plans they've chosen
this assistance translates into
substantial financial yields
financial analysts morningstar estimate
that investors with advisors outperform
other investors by two to three percent
per year
advisors can offer essential support
during a crisis
imagine that you had invested your
entire life savings only to see the
market plunge in the financial crisis of
2008
it would be enough to send any investor
into a panic
indeed most investors struggled during
the period following the crash
however financial consulting firms aeon
hewitt and financial engines
found that investors who had assistance
during the critical years of 2009 and
2010 actually outperformed other
investors by 2.92 percent
advisors don't just help their clients
to weather difficult periods by
providing lists of statistics and
probabilities
the best advisors also act as behavioral
coaches giving their clients a much
needed reality check when it comes to
their emotional decisions
for example advisors can be professional
devil's advocates helping you do a
pre-mortem when considering an
investment decision
by asking you lots of challenging
questions they can help you to think
through everything that could go wrong
with an investment
when you're full of enthusiasm this may
be the last thing you feel like doing
but it could save you major losses if
the potential investment survives the
pre-mortem then it might just be a
winner
of course not all advisors are good or
right for what you need
before hiring someone make sure that you
interview her rigorously about her
credentials investment philosophy and
communication style
most importantly make sure that along
with investment advice she's also a
master at behavioral coaching
as we have seen this is where the most
value lies
four
don't panic about investment panic
imagine investing part of your life
savings in a company only to hear that
the company is being investigated for
fraud
chances are you'll be flooded with
feelings of panic
unfortunately as an investor you'll be
bombarded with information by news
organizations hungry for scandal and
disaster
if you're not careful you'll be unduly
influenced by such reports and end up
acting out of fear instead of good sense
humans have a tendency toward
catastrophizing
that means that as soon as you hear
something alarming you will immediately
start imagining the worst consequence
that could result
hear that your stock has taken a little
dip
next thing you're probably imagining
that you will live out your retirement
on the street relying on your grown
children for handouts
while the media treats every dip in the
stock market as an alarming crisis
in fact it is very normal for your
stocks to lose value from time to time
sometimes the value of stocks is over
inflated and when this happens people
start selling their stocks on mass to
profit from the high prices
this leads to the value of the stocks
plummeting sometimes losing over 10
percent of their value
this is called a correction and it
happens approximately once a year
these dips actually don't affect the
value of your stock portfolio in the
long term however if your reaction is to
sell your stocks immediately then your
portfolio will suffer as you'll be
selling them at a loss
ironically we're most scared at times
when the market is actually safest
in times of great prosperity you may
feel very confident
however high valuations can be an
indication of a bubble
once the price drop has happened and the
market has corrected itself you may feel
terrible but in fact it is an indication
that the market is much safer because it
reflects a more accurate valuation
so make sure that you don't jump at the
first sign of trouble
weathering tremors in the market is part
and parcel of being a successful
investor
five
learn to identify a dodgy company by
evaluating what the management does not
what it says
we've all heard the cautionary tales
about con artists operating on wall
street
nobody wants to be suckered into
investing in the next ponzi scheme
but how can we avoid falling prey to the
bernie madoffs of this world
we may like to think that we'd be able
to see through a con artist relying on
our intuition and powers of detection
unfortunately research has shown that
we're terrible at detecting when someone
is lying
in a paper published in personality and
social psychology review in 2006
psychologists charles bond jr and bella
de paolo analyzed the results of 200
studies about how people detect lies
they discovered that only 47 percent of
the time could people spot liars by
studying their body language
that means that you'll be more likely to
determine who is lying by flipping a
coin than by analyzing their behavior
even people with expert training are bad
at spotting liars
in an experiment conducted in a prison
law enforcement professionals were asked
to tell the difference between a true
confession from a prisoner and a fake
one
they were successful in only 42 of the
time
so what does this mean for us as
investors trying to decide whether we
can depend on the leadership of a
company
put bluntly we have to stop listening to
what executives are saying and start
looking at what they're doing
specifically we need to look at how they
are investing their own money
the managers of a company have the most
intimate possible information about
their own business
is that inspiring them to buy their own
stock or to sell it off as quickly as
possible
a study by the private investment firm
tweety brown published in 1992
found that companies with significant
insider buying patterns outperformed
other companies on the stock market
they gained two to four times as much
value during the same period
if insiders are betting on a company it
is likely to be a very good bet indeed
instead of fighting a losing battle to
try to determine whether leaders are
telling the truth about their companies
just look at where they invest their own
money
actions really do speak louder than
words
6.
the highest price isn't always right
so when investing go for value over
glamour
would you pay 52 dollars for an old
burnt oven mitt
what if you were told that it was the
oven mitt that it belonged to none other
than the famous chef and cookbook author
julia child
and that it had gotten burnt as she was
making her first ever batch of delicious
beef bourguignon
chances are you'd be much more willing
to reach into your pocket to acquire
something with such an interesting and
socially significant past
when it comes to buying stocks we have
to be aware of how irrational we can be
about pricing
in fact we often believe that a product
is valuable just because it is expensive
rather than evaluating it on its
objective merits
stanford professor baba shiv conducted
an experiment in which he measured
participants brain activity in an fmri
machine as he fed them droplets of wine
he told him that some bottles of wine
cost ninety dollars per bottle and
others only ten dollars
the scan showed that the pleasure
centers in people's brains lit up much
more when they were drinking the wine
that they were told was more expensive
however as you might have guessed all
the samples were exactly the same
just believing that the wine was more
expensive made them derive more
enjoyment from it
assuming that price is the same as
quality may not be such a big deal when
it comes to buying wine but there can be
terrible consequences if you use that
reasoning to buy stocks
glamour stocks usually come from
startups and fast growing companies
they rise in value quickly and are very
appealing to investors
however if you buy those stocks at the
height of their popularity you may make
an unprofitable investment
you're paying a lot of money for
something that is probably not going to
increase in value substantially and may
even lose money when the bubble bursts
if you really want to make a sensible
investment in the stock market you need
to invest in value stocks
these are stocks that are often rather
unpopular because they come from
companies that may be smaller and thus
lack brand recognition or social cachet
they certainly won't be the highest
priced
this means that they have room to grow
in value and seeing as you have paid a
fair price for them your investment is
much less risky
picking a value stock is counter
intuitive like choosing the kid who gets
picked last for the basketball team
instead of the popular lanky jock known
for scoring
but just like the unpopular kid might
surprise you by putting up a steady and
solid defense the value stock may be
likely to live up to its name quietly
gaining ground while glamour stocks soar
and then crash
7.
be wary of being seduced by novel and
exotic investments
in the early 1600s the tulip came to
prominence in the netherlands
people were astonished by its beautiful
color and an exotic shape they had never
seen in a flower before tulips became
the ultimate status symbol
as demand increased so did the price
people became willing to pay up to 10
times a worker's annual salary for just
one bulb
in 1637 the tulip frenzy spectacularly
crashed in what is thought of as the end
of the first speculative market bubble
what is it about the new and exotic that
elicits such great enthusiasm
after all the tulip bubble has been
repeated over and over in economic
history
a much more recent example is of course
the dot-com bubble which had many
casualties
people were so excited by the seemingly
endless possibilities of the internet
that they thought any investment ending
in dot com would be a sure bet
for example an internet startup called
etoys.com
founded in 1997 had attracted a
mind-boggling investment of eight
billion dollars by 1998 even though it
could only report 30 million dollars in
actual toy sales
in contrast the conventional boring toy
company toys r us could boast 40 times
as much in sales with only a 6 billion
investment
they also had a website but as they were
seen as traditional and old-fashioned
they didn't provoke investors excitement
in 2001 etoys.com went bankrupt and it
was later bought out by toys r us
investors had been prevented by their
excitement from making a good rational
assessment of the company
a similar story can be seen with air
travel an industry synonymous with
exoticism and excitement
thanks to air travel a journey that used
to take several weeks by ship can now be
made in the space of a day
the impact on how we live work and think
about the world has been immeasurable
investing in this industry for the
purpose of making money however has
always been a losing battle
with enormous fixed costs strong labor
unions and rigid pricing models
investors in air travel have
historically lost money
so when tempted to invest in something
exciting and new we should all bear in
mind the image of that beautiful exotic
tulip with the tantalizing colored
petals
yes it is lovely to look at
but is there substance behind that
beauty is it really worth ten times your
annual salary
eight
we need to invest our money according to
our personal goals
rather than other people's rules
how much money is enough
there are so many different ways to
answer that question
you could look at guidelines that say
you need to have 10 times your annual
income saved to be financially
independent or you could compare
yourself to your neighbors and decide
that when you have a fancier ferrari
than theirs then you'll be doing well
the best way to answer that question is
actually to look inward rather than
outward
each of us has a unique hierarchy of
needs the things that are most important
to our fulfillment in life
after the obvious common human needs
like food and housing have been met
personal needs can differ
wildly some people need several times
their annual income and savings to feel
secure and pay for their children's
college education
for others it's much more important to
have ready cash at hand to fund
experiences like traveling the world
these values are your personal benchmark
and they will determine how you invest
having this benchmark clearly
articulated to yourself
can help you survive the turbulence of
the market with your mental health
intact
for example if you know that you will
only need to access your savings in 15
years you won't be so concerned about
every dip in the market because you know
that there's time for the value of your
stocks to recover
on the other hand if you are currently
supporting an elderly parent with
unpredictable health care costs you need
an investment plan that is less risky in
the short term and which will allow you
to access money quickly if you need to
so how do you make sure your financial
decisions align with your goals
one important way is actually to change
how you talk about your money
former u.s president barack obama and
his advisors knew the power of language
very well when they decided to label the
money pumped into the economy after the
great recession a bonus
people were more likely to see it as
something extra and spend it immediately
rather than save it
we can use this behavioral psychology to
our advantage if we explicitly name what
the purposes of our savings and
investments are
one study showed that low-income couples
were much more likely to put money aside
for their children's college education
if they deposited it in an envelope that
had a picture of their children's faces
on it
it can be very motivating to know why
you are investing your money
next time you're considering making an
investment think carefully about your
own needs and values and make sure that
the decisions you make align with your
goals and dreams
the author asserts that one of the main
risks to investors comes not from the
stock market but from their own behavior
we are often emotional irrational and
prone to grandiose thinking we need to
learn how to recognize these weaknesses
and take steps to combat them by getting
outside advice and investing
systematically according to our personal
goals
as for what you can do now
learn a few simple rules and ignore the
rest of the advice you receive
it's easy to become completely
overwhelmed by the volume of advice
available about investing
however you don't need to become an
expert on the stock market in order to
become a good investor
just like an amateur poker player can go
far if he simply learns to fold his
worst hands and bet on his best ones a
novice investor can become very
competent just by following a few simple
rules
for example he should learn not to
overreact to dips in the market and make
sure to purchase value stocks instead of
glamour stocks
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