Source: Qilehui
Author: Guo Pan

Since investment is closely related to our own interests, the weaknesses of human nature will be fully exposed during the investment process.

To make investments effective, investors not only need to recognize various weaknesses of human nature but also find ways to overcome these weaknesses. Many times, investors' decisions are correct, and their plans are perfect, but the final result still ends in failure.

Even though we know that many failures are caused by the weaknesses of human nature, and despite knowing we need to overcome these weaknesses as much as possible to prevent them from affecting our investment behavior, it is much easier said than done.

This article explores the important role of human nature in investment through three true stories.

"Father of Macroeconomics" - Keynes

John Maynard Keynes was a British economist, renowned for pioneering the "Keynesian Revolution" in economics, and is referred to as the "Father of Macroeconomics" by later generations.

Keynes not only holds a prestigious academic position in the field of economics but also possesses deep insights and achievements in investment. His investment talent can be directly evidenced by the performance records of the Chester Fund located at King's College, University of Cambridge:

From 1927 until his death, Keynes was the sole head of the Chester Fund. During his 18 years of management, the Chester Fund achieved an average annual ROI of 13.2%, while the UK stock market remained in a persistently sluggish state, with an average annual ROI of -0.5% during the same period.

In a memorandum to the Property Committee of King's College, University of Cambridge in 1938, Keynes summarized his investment career and experiences: "In fact, the main lesson I learned from the above experiences is exactly the opposite of what I believed 20 years ago. At that time, when I first suggested to the College to invest in common stocks, I believed that a strategy known as the credit cycle could be profited from, namely holding stocks during a depression and selling during a boom.

We successfully purchased some Stocks when prices fell significantly. However, we failed to better utilize regular market fluctuations to buy and sell Stocks at different phases of the cycle. These short-term declines in Stocks and our failure to effectively harness market volatility did not affect the ultimate success of our investments."

What did he specifically mean by "what he believed 20 years ago" in his memorandum?

The biography "Keynes" states: "In the 1920s, he saw himself as a scientific 'gambler,' investing in Futures and MMF, aiming to play according to the economic cycle. This was his belief in the peak of ‘forecasting,’ as he thought he could become a market winner by predicting short-term changes."

However, he experienced two failed investments during his lifetime: the first was a currency investment in 1920, which initially earned him a fortune, but later ended disastrously due to excessive confidence and leveraging; the second was in 1927, when he used abundant probabilistic analysis tools to go long on CSI Commodity Equity Index, later facing a financial crisis that severely shrank his Assets.

Keynes had a profound understanding of the nature of investment, and he expressed many investment quotations, such as:

The time the market remains irrational may be longer than the time you can avoid bankruptcy.

Human life is limited, and human nature is always about quick results, so people have a special interest in getting rich quickly.

He has a unique insight into the market, and as he ages, his understanding becomes increasingly profound.

Like many of us, he has made countless mistakes in investing, but unlike most people, the mistakes he made made him even wiser, and he could even profit in some poor Industries, which is particularly notable in history.

"Father of Behavioral Economics" - Richard Thaler.

In 2017, the Nobel Prize in Economics was awarded to Richard Thaler, a professor at the University of Chicago known as the "father of behavioral economics," in recognition of his contributions to the field.

In theoretical research, he made significant contributions to anomalies, the economic man hypothesis, the endowment effect, intertemporal choice, mental accounting, and the stock market. In practical applications, he analyzed and explained consumer behavior through the ideas of nudging and choice architecture, as well as government policy behavior including social welfare policies and savings investment research.

In 1993, Thaler and his partners founded a fund company based on behavioral finance theory, focusing on small business stocks in the USA. The company's core philosophy is that "investors will make mistakes, and the company's goal is to find those mistakes."

The company profile also cites a line from a movie in which Saylor made a cameo appearance, saying, "To imagine humans as animals guided by logic is truly madness." The annualized return on a fund managed by Morgan, the undiscovered managers behavioral value fund, over the past ten years was 12.63% (as of 2019), ranking second among funds in the same category, with a top five-star rating from Morningstar.

Saylor's academic viewpoint is that completely rational individuals cannot exist, and people's economic behavior in real life is invariably influenced by various "irrational" factors. Many behaviors that are considered "wrong" from the perspective of traditional economics are often overlooked, but it is frequently these behaviors that lead to those seemingly beautiful decisions ultimately failing and resulting in adverse consequences.

An encyclopedic "polymath" - Newton.

Newton was an encyclopedic "polymath"; he discovered the three laws of motion, he shared the development of calculus with Leibniz, he proposed the gold standard system, and so on. Despite being such an exceptional individual, he suffered heavy losses during the "South Sea Bubble" event. The "South Sea Bubble" event occurred between the spring and fall of 1720, characterized by a dramatic price surge and collapse triggered by an unconventional investment frenzy, followed by widespread chaos.

In 1720, the South Sea Company promised to take over all national debt. As a condition for the trade, the government was to repay the company yearly, and the company allowed customers to purchase the company's new stocks through installment payments (only 10% of the price needed to be paid in the first year). On February 2, the British House of Commons accepted the trade with the South Sea Company, and the company's stock immediately surged from £129 per share to £160 per share. When the House of Lords also passed the bill, the stock price rose to £390 per share.

Investors rushed in, including more than half of the members of Congress, with even the king succumbing to temptation, subscribing to stocks worth £0.1 million. Due to the surging purchases, the company's stock price increased from £128 per share in January to over £1,000 per share in July, a surge of 700% over six months.

On April 20, 1720, Newton sold his shares in the British South Sea Company, realizing a profit of £7,000, but he later bought back the South Sea stocks. As the "South Sea Bubble" burst, Newton performed just like ordinary speculators, suffering heavy losses. He concluded, "I can calculate the motion of celestial bodies, but I cannot predict the madness of humans."

Someone described that crazy investment wave as follows: politicians forgot about politics, lawyers no longer engaged in lawsuits, doctors set patients aside, shop owners closed their shops for business, priests put down their Bibles and left the altar, and even reclusive noblewomen set aside their pride and vanity, with everyone rushing to the market to buy South Sea Company stocks, hoping to make a huge profit when the stock prices soared.

However, after the bubble burst, this crisis caused great chaos and had a significant impact on the United Kingdom, including both economic and political aspects. The "South China Sea bubble" incident remains an important counterexample for later generations, from which many lessons have been learned.

Summary

Essentially, human needs can be categorized into three types: the first type is greed for survival; the second type is seeking validation to conform; the third type is eliminating anxiety to achieve calm and tranquility.

However, investment occurs because the recognition of both buyers and sellers simultaneously increases, in pursuit of maximizing validation. This is human nature. Therefore, to be successful in investing, one must understand human nature and exploit its weaknesses, engaging in "anti-humanity" operations to win in the game of human nature.

In other words, when others cannot cut their losses, you must decisively stop losses; when others go against the trend, you should go with it; when others dream of getting rich quickly, you must be steady and pragmatic; when others are impatient and anxious, you must stay calm and composed...

Of course, achieving "anti-humanity" is indeed quite difficult.

Zeng Guofan once said, "In the world, there is nothing that can be sustained and expanded without coming from hardship." As long as you persist in deeply reflecting every day, identify your weaknesses, and earnestly correct them, even if you cannot be fully rational, you can at least get infinitely close to rationality.

As Munger said, "You must sincerely and diligently strive for rationality; you must value and care for rationality." If you don’t even care, you won’t put in the effort to be rational, and you may remain irrational for a lifetime, ultimately facing terrible consequences.

Editor/rice