Message Font: Serif | Sans-Serif
No. of Recommendations: 0
All I'm pointing out is that introducing emotion and prejudice into the investment process makes it more inefficient.

It is not so much that it DOES cause inefficiencies as that it CAN.

Part of the confusion was probably caused by the way I phrased my statement (in bold). What I should have said is "that introducing emotion and prejudice into the investment decision-making process makes it more inefficient."

In other words, I am only referring to the actual processes by which you make investment decisions; I am not referring to the return on your investment. The decision-making process is made more inefficient because you are now subordinating the goal of optimum returns to some other goal. This may or may not affect your actual returns (what you were referring to as an "effectiveness"). I could have made this point much clearer, and I can understand your confusion at my use of the word "inefficient."

However, if the choices that are eliminated by prejudices would have been eliminated anyway, then the prejudice has not impact on efficiencies.

Well, your decision-making process was inefficient because you were devoting resources away from the primary goal (optimizing returns). It's just that it still resulted in an effective strategy. I fully agree with your Botswanan Mango Futures analogy - eliminating that as an option only limits your effectiveness if Botswanan Mango Futures prove to be a better investment.

I believe that the most commonly held prejudices tend to eliminate excellent investments, though. Take tobacco companies. I believe Philip Morris (MO) will prove to be an outstanding investment over the next couple of years. I was seriously contemplating selling SBUX to buy MO. I still may. Someone who refuses to invest in MO because of anti-tobacco prejudices is eliminating a well-established, high-yielding, undervalued DJIA component stock that could well prove to be a better investment this year than many of the high-flying tech stocks. Another example would be the LINUX fanatic who refuses to invest in the evil empire, Microsoft.

The prejudices don't have to be negative to make the decision-making process inefficient, though. The MI board is littered with posts from people who want to "tweak" the strategies just because they prefer one stock over another. It's extremely difficult to remove emotion. I don't yet claim to be able to do it; all I can say is that I attempt to.

So I agree that an inefficient decision-making process does not necessarily lead to an ineffective investment. In order to optimize my returns, however, I want to ensure that I am devoting all resources toward achieving the primary goal (optimizing returns) and not wasting resources in pursuit of some other goal (satisfying my personal biases, either positive or negative).

Your argument really seems more targeted at the fact that our research is being limited, thus potentially causing us inefficiencies in our portfolio. Again, I would argue that that would be dependent on ones prejudices.

Yes, it is dependent on the individual's prejudices.

The largest problem that I see with you argument is that it is truly an argument for only holding one stock in your portfolio.

Whooooaaa...I did not mean to imply that was an effective strategy in reality.

If you are referring to the Ideal portfolio, than yes - the Ideal portfolio would be 100% invested in only one stock at any given time. But the Ideal is just that - Ideal. It can never be made real. You and I will never, ever, ever manifest the Ideal over any interval. The whole purpose of the Ideal is just to define the function of a portfolio, the ultimate purpose, the goal you are shooting for. It's not meant to be manifest in reality; it's just to help us keep in mind a picture of why we're doing what we are doing.

Now, we can work to approximate the Ideal, which is what we do when we make investment decisions. We attempt to make the best decisions possible in realizing our goals. But for me to assume that I can automatically approximate the Ideal by just investing in one stock at any one time is foolhardy. We get closer to the Ideal by formulating better and more effective investment strategies, by learning from our mistakes, through dialectic and discussion, by employing the scientific model, etc.

Unless equal return is expected from several positions, holding more than one position is not efficient. That does not appear to be what you are advocating, but isn't that truly the logical conclusion.

For the Ideal, yes. For us in the real world, we cannot realistically predict (with absolute certainty) the return on any one investment, and so we have account for this by holding more than one position in order to optimize our returns. At least, I have not yet found an effective strategy that holds only one position at any one time. Then again, I really haven't started looking for one-stock strategies, either. :-)

Another logical conclusion would be that if our tolerances for risk are equal, then we should be holding the same portfolio were all prejudices and emotions eliminated.

For the Ideal, yes.

I know this digresses from your original point, but do you believe that putting emotions aside we will all
come to the same conclusions?

In reality? No.

If not then what is it that would separate our portfolios, as one will be more efficient than the other?

Our investment strategies would still probably differ, even if we could put our emotions aside. My beliefs about what was the most effective investment strategy would still differ from yours, and so we would probably choose different strategies, even though our decision-making processes were made more efficient through the removal of emotional biases. Because we wouldn't have a crystal ball, we'd still be trying to predict the future, and our predictions would still probably be different.

Print the post  


What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and Glassdoor #1 Company to Work For 2015! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.