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Monday, November 30, 2015

The Mother of All Investing Mistakes by Vishal Khandelwal

What would you do if you had something coming at you at 110 km an hour and less than half a second to react?

Soccer goalkeepers saving penalty kicks face this situation often. While watching penalty kicks looks like a lot of fun for the audience, it’s often a tricky situation for the person facing the penalty i.e., the goalkeeper. He has to make a decision in less than a second and that too a decision on which the balance of his team’s fortunes hangs.

Penalty kicks are a great way to understand one of the biggest mistakes investors make. More on that later, but first let’s talk about the options in front of the goalkeeper saving the kick.

He has three choices available – He can dive left, dive right, or stays put.

As per research on penalty kicks, the players taking the kicks shoot one-third of the time at the middle of the goal, one-third of the time at the left, and one-third of the time at the right. Goalkeepers and their coaches surely know of this these days.

But what do most goalkeepers do?

Roughly 95% of the time, they dive left or right. And why?

Top goalkeepers said it just feels like they are at least making an effort when they dive. They feel like they’re being lazy if they just stay in the centre. It feels right to just do something, to make an effort. And it feels wrong to make the least effort i.e., stay put at the centre.

Staying put at the centre is surely the right thing to do, at least this is what research suggests. When the kick is to the centre, goalkeepers stop it about 60% of the time. When the kick is to the left, and the keeper dives left, his success rate falls to just below 30%. And when the kick if to the right, and the keeper dives to his right, his success rate is even worse at about 25%.

Now before you blame the goalkeepers for their foolishness despite knowing what works (as per probabilities) and what doesn’t, see the big mistake you may have made often in the past (and probably continue to make) as far as your stock investing is concerned.

That mistake is your bias towards action i.e., doing something. Anshul has written about this in his latticework of mental models series in August, but I thought this is worth reiterating given that I see a lot of people around trying to second guess the movement of Mr. Market and trying to be in the thick of action all the time.

Contrast this with a Warren Buffett quote I’ve come to agree with over the years –

Lethargy bordering on sloth remains the cornerstone of our investment style.

Or how Charlie Munger sums up his approach to investing –

We’ve got…discipline in avoiding just doing any damn thing just because you can’t stand inactivity.

Or the cause Blaise Pascal found for our biggest problems –

All of humanity’s problems stem from man’s inability to sit quietly in a room alone.

Being overactive as a goalkeeper or an investor is clearly crazy. Often staying put – not doing anything and instead sticking with your chosen investment process and high quality stocks – is the right thing to do.

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