0:46
In a small town, in a small village in India, a man marches
to the town square everyday at a designated time.
Let's say, 6 o'clock in the evening carrying a flag and a trumpet and
when the man reaches the appointed spot, he brandishes the flag and
blows a few notes on the trumpet then he returns home to the delight of his family.
A regular person notices this person's activity every single day and
eventually asks him, what are you doing?
The man replies, I'm keeping elephants away and
the village elder says, but there aren't any elephants in our village.
>> The person says well, then I'm doing a very good job, aren't I, aren't I?
So at this person the rolls his eyes, and laughs.
This rather absurd tale illustrates the fallacy
inherent in the illusion of control bias.
So in the investment world,
illusion of control bias can lead investors to trade more than is prudent.
It's been found that online traders believe themselves to
have more control over the outcome of the investments than they actually do.
And in the end an excess of trading results in decreased returns.
A leisure of control can also lead investors to maintain
under diversified portfolios.
2:14
Researchers found that investors hold concentrated positions because they
gravitate towards companies over whose fate they feel somewhat control.
So if I'm an investor and I feel somewhat of control over the fate of a particular
company, then I gravitate towards that particular company's stock.
In fact that control almost always proves illusionary and
the lack of diversification eventually hurts the investor's portfolio.
Illusion of control buys can also cause investors to use limit orders and
other such techniques which we have discussed in the first course.
And the expedience of falls control over the investment.
In fact, the use of these mechanisms most often leads to
an overlooked opportunity and even worse,
a detrimental unnecessary purchase based on the occurrence of an arbitrary price.
3:15
Illusion of control bias contributes in general to investors overconfidence.
So how to avoid this?
Basically, there are four advisors or suggestions that investors can
implement to stem the detrimental effects of illusion of control.
First, is to recognize that successful investing
is even in the best of times, a probabilistic activity.
So the first step on the road of recovery from
this particular illusion is to take a step back and
realize how complex the global financial markets actually is.
The financial markets are fairly complex,
even the wisest of investors don't have much of a chance and
have absolutely no control over the outcome of the investments that they make.
The second suggestion is to recognize and
award circumstances that trigger illusion of control.
So the example that I give of the villager blowing his trumpet every
day at a designated time and no stampede of elephants happen.
Now we know that the trumpet of course doesn't really keep the elephants away.
So applying the same concept to investing, just because I
as an investor have deliberately determined to purchase a stock.
Do I really control the trade of that stock or
the outcome of that particular purchase?
Rationally, if I think about it,
it becomes clear that some correlations are actually arbitrary rather than causal.
So I shouldn't permit myself to make financial decisions on what I
logically discern as an arbitrary correlation which is essentially,
the basis is quite arbitrary.
The third position is to actually seek contrary viewpoints.
Let's say, I contemplate a new investment.
I should take a moment to ponder whatever
considerations might weigh against the trade.
I should ask myself, why am I making this particular investment?
What are the downside risks?
When will I sell it?
What might go wrong?
These questions can help me to screen the logic behind the decision
before implementing that decision.
The last suggestion is that once I have decided to move forward with
an investment.
One of the best ways to keep the illusion of control at bay is
to maintain records of my transaction, including reminders and
spelling out the rationale that underlie each trait.
Sometimes if you write down some of the important features of each of
the investments that you mean, and emphasize the attributes that you
have determined to be in favor of the investment success.
I've had the chance for looking at some very good investors, and normally give
the example of the renowned former Fidelity Microfund Manager, Peter Lynch.
Peter Lynch was a meticulously record keeper, was a very good record keeper and
would document his opinions on different companies at every opportunity possible.
When I was in Western Bank or JP Morgan our team along with our
managing director had the occasion to visit fidelity and
meet Mr. Lynch, who was an acquaintance of her MB.
So our team basically just went up to say hello, and
we had a fairly long conversation with Mr. Lynch.
And what I saw and heard was quite astounding to me
because I realized that Lynch actually made things.
A very good archive of notebooks filled with information.
His office is literally filled with research papers.
It's not a very clean place, it's actually filled with research papers.
And he shared with us that he expects his subordinates to be equally tough as he is.
So when analysts would make a recommendation lecture actually that
require a written presentation outlining the details and
the basics of each recommendation.
Now, I think all investors should strive to get to that level.
We may not be able to reach that level of standard sophistication and
metaclystic art giving that Lynch has done and
the standards that he has set for himself and others.
But at least, an average investor should strive to reach to at least
a considerable, a certain amount of level that Lynch has set,
the standard that Lynch has set for himself.
Rationally, we know that returns on long term investments are in turn impacted by
Immediate things that surround a financial transaction.
So profit or loss on investment thereof is usually a result of uncontrolled
factors like corporate performance and general economic conditions.
So an illusion of control on those corporate performances or general economic
conditions is actually more often than not or almost always misplaced.
[MUSIC]
Vaidya NathanLecturer
