#
You're sitting at a table with eight other people. All of you have chips in front of you. Those chips represent money.
#
Together those chips on the table constitute a small fortune. Four cards are laid on the table face up.
#
You have two cards in your hand. So does another person whom you have come to hate in the last five minutes.
#
You are all playing poker. We've reached what is known as a turn and this is the biggest part of your life.
#
Your opponent has just gone all in.
#
The room is air-conditioned, but you're sweating profusely. You think for a while and finally decide to call.
#
You sigh with relief when he shows his cards. You have two pair, a much better hand than him.
#
He only has a flush draw.
#
He will win this hand less than 20% of the time. If the river is anything but a club, you will win a huge pot.
#
There is enough money here to take you on a long luxury holiday in the Bahamas.
#
Then, the one remaining card, the river, is opened up. Your opponent screams like a madman.
#
What was a great decision moments ago seems like a terrible one.
#
Welcome to The Scene and The Unseen, our weekly podcast on economics, politics and behavioral science.
#
Please welcome your host, Amit Verma.
#
Welcome to The Scene and The Unseen. I used to be a professional poker player for a few years and since leaving the game,
#
I've believed that the lessons I learned from poker were very applicable to life.
#
I've often spoken about poker with a close friend of mine, Mohit Satyanand,
#
who is an ace investor and is known for his expertise in stock markets.
#
He now sits on the board of several companies. He's an angel investor and he also manages money in the stock markets.
#
Now, whenever I talk about poker with him, he'd always remark at how similar it was to stock investing,
#
so much so that we've just decided to write a book together about the similarities between poker and the stock market
#
and the lessons they hold for life itself.
#
So, I've invited him on the show today so we can talk about exactly that. Mohit, welcome to the show.
#
Thanks, Amit. So, poker stocks and life or poker stocks and lies?
#
Poker stocks and life or poker stocks and lies?
#
Well, I mean, aren't they the same thing?
#
I like to think that there's more than lies to life.
#
This is quite interesting, Amit. What you're really implying is that firstly, the decisions may turn out to be wrong
#
because there are probabilities to life. There's no certainty except death.
#
You're roughing to the story of the hand I started the episode with.
#
But that you've got to take the right decision and the right decision doesn't necessarily have to turn out right.
#
It's a question of assessing the odds well in advance of taking the decision and things may turn against you sometime.
#
So, I like to think that the feedback loops of developing judgment in the stock market
#
probably take a little longer and a little more detailed understanding, more factors than a game of cards.
#
But I could be wrong there because I don't know the poker. But the broad parallel still remains.
#
Let me tell you how it is in poker. When I started playing poker, one of the first things you learn is not to be results oriented.
#
Now, someone from the outside may say, what the hell does that mean?
#
Of course, you have to be results oriented in anything to know whether you're doing a good job or not.
#
But poker happens to be a game, what I call a game for the long term, in the sense that let's say,
#
let me give you a simple example which has nothing to do with poker.
#
Let's say you have a coin which is absolutely evenly weighted.
#
And someone offers you a bet that, listen, every time we spin that coin, if it's heads, I'll give you 51 paise.
#
If it's tails, you give me 49 paise.
#
Now, I know the coin is evenly weighted, so it's a no brainer. I will keep betting on heads.
#
Now, the thing is, that is a correct decision to bet on heads and in the long run, I'll make a lot of money.
#
But in the short run, they could be five tails in a row.
#
In fact, over a long enough sample size, you're bound to have even a hundred tails in a row if you have millions and millions of iterations.
#
And what happens often in poker is in similar situations when you have the analog of five tails in a row or ten tails in a row,
#
people get disheartened or they start betting on tails, which conforms with another fallacy we'll discuss later in the show.
#
Which is why we are taught that just focus on making the right decision given the information available to you and your judgment.
#
And in the long run, the results will come. But if you focus on results, then you'll end up all wonky.
#
Absolutely right. So in the stock market, we say that in the short run, the stock market is a beauty contest or a popularity contest.
#
But in the long run, it's a weighing scale, which is the same thing.
#
What it means is that in the long run, the performance of the company on objective criteria,
#
which is primarily its ability to generate cash, is what matters in the short run.
#
And sometimes that short run is fairly long. What seems to matter is extraneous factors which drive the popularity of a stock,
#
which could be some so-called famous investor has backed it or some famous promoter has just set up this business or a particular sector is a fad.
#
So if you look at that, you could think of the dot-com era of 99 and how it crashed and so on.
#
But in the long run, there is an objectivity to it.
#
And your skill as an investor is determined by your ability to get under the hype, the positive or the negative hype,
#
around a stock and try and analyze objectively, firstly, the sector that you're investing in,
#
what kind of developments that sector is likely to face in the medium term in the economy in which you're investing,
#
and thirdly and most importantly, the ability of the management,
#
your assessment of the ability of the management to manage that particular environment in which they're functioning well.
#
Now, these are judgments which you develop over a period of time.
#
And reviewing the decisions therefore becomes important because they refine your judgment.
#
So looking back has its value, but only in so far as it improves the processes by which you think,
#
improves the number of factors which you analyze to try and improve your ability to predict an outcome.
#
But just because the outcome is not positive doesn't mean that the process was wrong,
#
doesn't mean that the decision was wrong and doesn't mean that you will be right 100% of time.
#
Because the other eternal truth in the stock market is that if you never lose money in a stock, you're not taking enough risky bets.
#
Absolutely. And I guess a classic example of this to my layman mind is that you know that there's a bubble going on
#
and you know that at some point the market is going to crash.
#
So obviously the smart thing is to bet on it crashing into short stocks or whatever.
#
But like that famous saying goes, the markets can stay irrational longer than you can stay solvent.
#
And in that case, you might be making the correct decision and you might be making the correct call,
#
but the results simply aren't with you.
#
Well, so there are at least three ways of looking at this.
#
This is something which anybody who's been in the markets long enough
#
has developed some kind of views on how to manage it because you've been through it a few times.
#
So let me tell you a little story, which is that in 99, there was this development of the IT sector, right?
#
And in those days, I was living in the mountains and I wasn't really cognizant of all that was going on.
#
My stockbroker asked me to buy this unknown company called Infosys.
#
So I valued my stockbroker's advice.
#
He told me how the company was extremely well governed, et cetera, et cetera.
#
So I bought the stock at 3,500 rupees.
#
Two weeks later, when I next had access to the newspaper, I saw it was 4,500 rupees.
#
When I went down to Delhi next, it was 6,500 rupees.
#
And this time I sat down for the first time and actually started looking at the income statements and so on.
#
Now, my objective analysis told me that a proper valuation of the stock at 6,500 rupees
#
would require it to see its income go up by 50% per annum for the next 10 years.
#
No stock I knew had ever done that.
#
And so I realized it was time to sell.
#
My broker said, sir, this will cost 10,000 rupees.
#
I said, it may be 12,000. Please sell.
#
Now, in January, four months later, the stock was 11,000.
#
But by December of the next year, it was 1,000.
#
So the question is, did I take the right decision or not?
#
Should I have waited and gotten out?
#
Now, this is a very simple way of looking at it.
#
The question you raised, if I knew it was a bubble,
#
is it enough to exit the stock or should I try and short it?
#
The answer is it's right to short it.
#
But the second question that follows is, how much should I short?
#
Should I bet the bank on shorting it? Answer, no.
#
Because if the market stays foolish longer than I can stay solvent, I'm broke.
#
So then you have to manage your funds and say that I will bet a maximum of 2%,
#
for example, of my net worth on shorting this particular stock.
#
And then I think there's a parallel with poker.
#
Absolutely. I mean, which is something I was going to come to,
#
but to sum up what we've already spoken about,
#
and it's sort of there in the Bhagavad Gita where Lord Krishna says,
#
don't worry about the fruits of your action, just do the right thing.
#
And that kind of focus on process over results is something that you see,
#
for example, in modern day sports.
#
It's very much the philosophy of the current Indian cricket team.
#
I mean, Virat Kohli himself believes in it and would therefore perhaps be a good poker player.
#
But to come back to the point you've just come to,
#
I mean, this is absolutely critical, which is bankroll management.
#
It's not enough to take the right decision.
#
You have to take the right decision under the understanding
#
that you're going to get unlucky a lot of the time,
#
and the right decision is going to lead to the wrong result.
#
And only over a certain number of iterations or a large enough sample size,
#
whether it's a period of time or a number of hands,
#
are you actually going to be profitable,
#
and you have to make sure you stay solvent through that.
#
So in poker, I mean, the term we use for that is of course bankroll management.
#
And in poker, it's very critical that you don't play beyond your means.
#
If you have a bad run and you get broke, that's the end of the story.
#
And players are advised that if you're entering a certain game,
#
your total bankroll should be a certain multiple of whatever the buy-in is.
#
Or if you're playing tournaments,
#
your total bankroll should be a multiple of your average buy-in,
#
and so on and so forth.
#
And the same concept, I think, applies to pretty much anything in life.
#
And interestingly, this is true not just of shorting the market
#
or taking positions in the forward market.
#
It's also true of getting into stocks which are willing to hold for the long run.
#
And then it applies in a slightly different way,
#
which is that you buy a stock for all the good reasons,
#
and the stock goes down 20 or 30 percent.
#
And obviously, you relook at the process by which you made the decision,
#
and if you realize that you didn't factor something in, something has changed,
#
then the intelligent thing is to exit.
#
But perhaps we should talk about exits separately.
#
The question then is that the popularity contest,
#
which is a stock market in the short run, has taken the stock down.
#
But your weighing scale is telling you that the stock is even more attractive today
#
because it's available at a cheaper price.
#
Now the intelligent thing to do is to buy more of the stock.
#
But you can only do that if you've managed your cash balances properly.
#
Otherwise, you're all in, and there's nothing more to put into this stock.
#
So managing the cash you have, how much you hold in reserve to buy fresh stocks,
#
is a talent which you acquire only gradually as a stock investor.
#
And one of the things I wanted to do over the years was,
#
as I was playing poker from before that, I was a columnist, I write about economics,
#
and I got deeply interested in behavioral economics.
#
And it turned out, I realized in my years playing poker,
#
that a lot of the cognitive biases and the faults in the way we think,
#
so to say the bugs in the machine that is our brain, are very applicable to poker.
#
And I always thought that it would be fascinating to sort of write a book about the parallels,
#
about how they impact poker, and now we're writing one together where a lot of them will feature.
#
So why don't you throw some of those cognitive biases at me?
#
Tell me how they work in poker, and I'll tell you how they work in stock market.
#
So the first one is the sunk cost fallacy.
#
Now the sunk cost, I'll again define these terms formally.
#
The definition of a sunk cost is, a sunk cost is any past cost that has already been paid and cannot be recovered.
#
And the sunk cost fallacy says that individuals commit the sunk cost fallacy
#
when they continue a behavior or endeavor as a result of previously invested resources.
#
Now a real world analogy of this is that let's say I pack lunch at home, and I take it to my office.
#
And then when I'm in office, we find out that there's an awesome Japanese restaurant has a 50% discount,
#
and everyone wants to go there, and then I say, no, but hey, I've got lunch back from home, it will be wasted.
#
And that lunch is a sunk cost, and the effort has gone into it.
#
The question I should really ask myself is, what would I really value?
#
What would be a good way to spend my time and my money?
#
And very often, if you get past the sunk cost fallacy, you'll go and have the Japanese meal.
#
And in poker, the way it applies is that let's say you are in a hand, and you start with a good hand,
#
and you put a lot of money in the hand.
#
But in a later street, you begin to feel that, hey, I may not be good.
#
Purely by dint of the money that you already put in the pot,
#
you say that, hey, no, I've invested so much money in the pot, I can't let it go.
#
And you end up throwing good money after bad and losing a lot more.
#
And of course, you have to take the money in the pot in account when you're calculating pot odds and so on.
#
But somehow, sometimes it's simply negative EV to continue at any cost.
#
But because you've already committed so many chips, you commit the sunk cost fallacy.
#
By EV, you mean expected value, right?
#
Expected value, absolutely.
#
So my favorite real life example, please indulge me, is when I go and see a movie with my wife.
#
And in 20 minutes, I say, this is horrible.
#
I can't watch this movie.
#
And she says, no, but we've paid for it.
#
We're going to watch it till the end.
#
So I try and explain to her the sunk cost fallacy, but she thinks I'm just being as clever as you.
#
Do you finish every book you start reading?
#
No, I'm a good student of economics.
#
I believe in the sunk cost fallacy.
#
So in the stock markets, this is very important.
#
So to give you an example, you know, when the current government came in in 2014,
#
there was a feeling that they would focus on infrastructure.
#
The infrastructure markets were very, very badly beaten down for various reasons,
#
a lot of which had to do with the crash of 2008.
#
And but a lot of people felt that Modi was going to focus on infrastructure and they got in.
#
And to some extent, I followed that idea.
#
I didn't throw a lot of money behind it, but I did throw something behind it.
#
But a couple of years later, when I looked at those kind of stocks that were in my portfolio,
#
it was clear that they were not performing well.
#
And this is where I began to diverge from somebody whom I taught this thesis through
#
where then we'd made sort of parallel investments.
#
And I said that from objective measures, which is, for example, interest rates,
#
interest rates were expected to crash hugely and that would facilitate investments in infrastructure.
#
The fall was quite moderate and more importantly, looked like they were bottoming out.
#
They were now going to start going up.
#
That bankruptcy mechanisms, even though thoughts had come into place, were not fully resolved.
#
So that thesis had not played out the way it was.
#
And I remember what this chap told me.
#
He said, but I have bought a lakh shares in this company.
#
As though that changed the nature of the reality in any way.
#
It didn't because neither Modi nor that company, nor anybody cared whether he had a lakh shares or crore shares.
#
The thesis was not working out.
#
So I took that haircut, exited those stocks.
#
And I think that day was the bottom point of performance of my portfolio.
#
I accepted the sunk cost, accepted the fallacy and exited.
#
And this is something which every investor at some point in time has got to learn how to do.
#
Otherwise, you just keep waiting for this mirage.
#
In fact, it's not just individuals who make this mistake with regard to investments.
#
Even governments do the same.
#
Governments are a lot worse.
#
About three episodes ago, we had an episode on behavioral economics with Nidhi Gupta, who works at the Takshashila Institution.
#
The example she gave of the sunk cost fallacy was the government's continuing investments in companies like Air India and PSUs,
#
which have already lost so much money.
#
But the sense is, hey, we've already sunk so much money into this, we can't let it go now.
#
And they sink in more good money after bad.
#
And in that case, of course, is our good money after our bad money.
#
So that's kind of ironic.
#
The next funder from behavioral economics, the endowment effect.
#
Now, the endowment effect is a hypothesis that people value a good or service more once a property right to it has been established.
#
Let me simplify this and give you an example of a classic study that was carried out in the early 1980s by Daniel Kahneman, Jack Nesh and Richard Thaler.
#
Kahneman won the Nobel Prize a few years ago, Thaler won it this year.
#
And in this study, they handed out mugs at random to half the people who were taking part in the study.
#
And then they told those guys to sell it, to put a selling price to it.
#
And they told the other lot, whom they call the buyers, to bid for it.
#
And what inevitably happened was that the price that the sellers quoted was twice, if not more, of what the buyers were willing to pay, which was completely irrational.
#
But what it showed was that once those people who had been randomly given the mugs actually owned those mugs,
#
they began to value it more than the people who didn't have the mugs in question, which is the endowment effect.
#
So, for example, if you ask a group of friends, hey, what car should I buy?
#
You will find everyone sort of recommending the car that they drive, because now that they have it,
#
they will rationalize their choice and value it much more than they otherwise should.
#
And similarly, if you ask a group of friends, what phone should I buy?
#
They are very likely to recommend the one they own.
#
And in poker, this is a great risk because people will often start with a starting hand, which looks really beautiful,
#
and continue with it longer than they should have.
#
Like if I'm not in a hand and someone asked me advice that,
#
Bhai mere paas jacks tha and it was a 10 high bloat and I thought I'm good and then this was the action.
#
And at some point you say, hey, you're clearly not good, just fold.
#
But when you're in the hand yourself, you become too attached, you get married to the hand, as they say,
#
and you can't let it go and does the endowment effect right there.
#
Absolutely. And, you know, firstly, to some extent in the stock market,
#
I see some kind of merging of the endowment effect and the sunk cost fallacy.
#
Secondly, for me as an investor in publicly listed companies,
#
I often say that I'm so much better off than the owner or the promoter of a company
#
because I don't or should not suffer from the endowment effect.
#
This is not a business that was given to me by my father and therefore I have to continue to run it.
#
I can take a core blooded decision and exit that stock.
#
It's also aided by the fact that I don't have a liquidity problem.
#
I own a quarter or tenth or a hundredth of a percent of that company.
#
That guy owns 50 percent, he can't offload it.
#
So in the stock market, endowment can be completely suicidal.
#
And it's the fact that you're not endowed with that stock in the sense of getting it from your grandfather
#
gives you the ability to be completely objective about it.
#
And getting wedded to a stock because you had it for five years,
#
because it did well in the past or whatever is a sure way to underperform in the stock markets.
#
I believe that every quarter or every year or whatever kind of periodicity you look at your stocks,
#
you must very cold bloodedly look at whether you are willing to buy that stock at that price or not.
#
And it doesn't matter whether you've held it for a year or ten or fifteen.
#
And I would say that a lot of people who commit the sunk cost fallacy and fall for the endowment effect
#
probably also suffer from the Dunning-Kruger effect.
#
Let me define this for you.
#
The Dunning-Kruger effect is a cognitive bias wherein people of low ability suffer from illusory superiority,
#
mistakenly assessing their cognitive ability as greater than it is.
#
For example, let me give you an example of this.
#
A famous survey was done recently where people who drove cars were asked how good their driving skills were.
#
And some 94% of the people said they were above average,
#
which of course is impossible because average is average.
#
Most people on average are average.
#
94% of the people can't be above average.
#
And another name for this is, for a similar sort of effect, not exactly this,
#
is the Lake Wobegon effect, which comes from, you know,
#
Garrison Keeler had created this fake town called Lake Wobegon,
#
where, quote, all the women are strong, all the men are good looking,
#
and all the children are above average, unquote.
#
And I often see this in poker where, if you're at any poker table,
#
you'll find that most of the players, if not all of the players,
#
think that they are better than the rest, think that they have an edge.
#
That's why they're there in the first place.
#
And the truth is, in poker especially, most of them don't.
#
I mean, eight out of nine players are probably losing players.
#
And one reason for this is they don't know enough about the game
#
and aren't self-reflective enough to know how much of the game they do not know.
#
And the flip side of this, of course, often is that,
#
the flip side of this is that people who are genuinely competent or good at something
#
underestimate their skills, partly because they think,
#
hey, if it's easy for me, it must be easy for the other guy,
#
and partly because the more you, you know, the old cliché,
#
the more you know about a subject, the more you realize how much you still have to know.
#
So, you know, I mean, I see this completely.
#
But I don't understand how people can do this in something as serious as the stock markets.
#
Because if you are into the stock markets at all,
#
then it should be a fairly significant portion of your net worths.
#
Now, this is real because we live in an economic society.
#
And at the end of the day, you're doing this because you want your money to earn superior returns.
#
To what? You've got to define to what?
#
To fix deposits or to putting the money in an ETF or to putting it in a mutual fund.
#
So you've got very, very clear benchmarks.
#
And as far as I'm concerned, I've reduced that also to a very, very simple heuristic,
#
which is that this is my benchmark.
#
My benchmark is, let's say, the nifty.
#
I don't want to get too sophisticated about risk-adjusted returns and so on.
#
My benchmark is the nifty.
#
I've told myself, and the best way to make sure that you do what you've told yourself
#
is to share it with a couple of other people.
#
So I've shared this with my wife and I've shared this with my sister.
#
And now all the listeners of The Scene and the Unseen.
#
Which is that if for two consecutive years I do not beat the nifty,
#
I'm going to stop managing my money because the objective numbers are telling me
#
that you cannot outperform the benchmark.
#
And therefore, why put yourself through this agony of managing money,
#
looking at the quotes every day or every hour or every minute,
#
depending on how obsessive you are about it, and give it to somebody else to manage?
#
So if you're playing the occasional hand of poker and you're playing it at stakes
#
which don't really matter to your back pocket, I can understand it.
#
But in the stock market, where you're investing a significant portion of your personal
#
and or your family's net worth, you can't afford to do something like that.
#
Even the Dunning-Kruger effect is not something that is applicable in some activities
#
I think it's just a human tendency.
#
I understand that completely.
#
What I'm saying is that you should not allow it to happen.
#
It's more difficult to assess my good looks or my driving ability.
#
There are no objective realities.
#
Here, this was my starting net worth.
#
This was the amount of money that I took out of my equity pot or put into it.
#
And this was my end result.
#
It just requires two minutes on a spreadsheet to tell you whether you beat the index or not.
#
Absolutely. And this also then creates a paradox and something that you need to balance
#
because on the one hand, you create these objective benchmarks of performance
#
to guard against the Dunning-Kruger effect.
#
But at the same time, as we mentioned in the start of this episode,
#
we shouldn't be too results-oriented, more process-oriented.
#
So the deal there is that you should be process-oriented and not look at short-term results.
#
But you should set yourself certain parameters so that over a certain sample size,
#
whether it's a number of hands in poker or a period of time in investing,
#
you can then look at the figures and be cold-blooded in judging whether you're Dunning-Kruger or not.
#
Absolutely. I think that's a very good point.
#
So when a friend comes to me and says,
#
I am now 27 years old and I need to start investing money for the future,
#
and what kind of return will I make, I issue a couple of cautionaries.
#
The first is that, look, building a portfolio is a very, very difficult task
#
because I know that in the long run, the stock is going to do well and in the short run, it may not.
#
And when the base is very small, both in terms of number of shares,
#
number of companies that you're investing in and the amounts, the fluctuations can be very violent.
#
So you must be prepared for that volatility in the short run.
#
But over a two, three-year time period, it all works out.
#
And then you take the call whether you can manage this kind of volatility
#
and whether these returns work for you or not.
#
So you're absolutely right. I'm not taking that call on a daily basis.
#
And in fact, it's those who take that kind of call on a daily basis,
#
like mutual fund managers, for example, who run into problems by measuring too frequently.
#
You've got to measure over a time span which is long enough.
#
So, you know, speaking of mutual funds,
#
I once wrote a very interesting post explaining the survivorship bias,
#
if I may call it an interesting post myself because
#
Musaid had the following thought experiment,
#
which has nothing to do with either poker or investing.
#
Let's say that you are someone who bets on cricket.
#
And one day you get an email from me that says,
#
I'll tell you the result of the next India-Australia match.
#
And if I am right and you don't have to pay me anything now, just wait and watch what I do.
#
And you wait and watch what I do and I get it right.
#
And then I get it right for the second match.
#
And for the third match, I say, if I get it right in this one, you pay me for the fourth one.
#
And so on. And by the fifth one, you're paying me good money.
#
Now, how the scam works is that I will write to a thousand people
#
and tell them I'm going to predict the result right.
#
And to 500 of them, I tell them India will win.
#
The other 500 say Australia will win.
#
And then for the next game, for the 500 who now are beginning to trust me,
#
And so on down the road till there are, you know, 50 people
#
for whom I've got four or five matches right in a row.
#
And they're paying me big money because they've made big money off of me.
#
And all this time, it's not my skill.
#
They think it's my skill, but it's sheer dumb luck.
#
And similarly, and this is…
#
And the law of large numbers.
#
And the law of large numbers.
#
And this is what you'd call the survivorship bias.
#
And this is something that can also apply to mutual funds.
#
For example, mutual funds that seem to have a good result over a period of years.
#
It doesn't mean that they're skillful or that it was, you know,
#
that their judgment is particularly good.
#
It can just be the case that out of a basket of like 30 mutual funds
#
with different strategies, one can just by pure chance
#
get this amazing, seemingly amazing streak.
#
And while that streak is inevitable, like you said, the law of large numbers,
#
to the outside investor who's sitting on the outside,
#
it seems like, wow, these guys really know what they're doing.
#
I'm going to put my money there.
#
And this is sort of the survivorship bias,
#
which comes up in the context of poker in different ways.
#
But is this something that you've thought about
#
or that you see a lot in the stock market?
#
Yeah, I've thought about it.
#
So one way in which it operates, of course,
#
is between two people who invest in stock markets on the side.
#
And they'll only tell you about the company which went up 100x
#
and they'll never tell you about the company
#
that bombed or they didn't even cover the cost of 4% savings deposit and so on.
#
So that's one form of it, and you get very enticed by it.
#
You know, on the mutual fund side, what is not true of the U.S.,
#
which is that mutual funds beat the index.
#
In a developed market like the U.S.,
#
they don't actively manage mutual funds, do not beat the index.
#
And therefore, there's a huge move into passive funds
#
which just track the index.
#
In India, there have been fairly significant mutual funds
#
which have beaten the index for very, very long periods.
#
And if you make the effort of looking at what they said 15 years ago
#
and 10 years ago and 5 years ago,
#
you find a certain logic, a certain strategy,
#
a certain ability to analyze the companies and the economy around them.
#
I think it goes a little bit beyond survivorship.
#
And there's something that has caused a lot of people to think very hard.
#
My case isn't that everyone who's successful is necessarily merely lucky.
#
But I'm just saying that as an investor, you should have that discernment
#
when you make those judgments about are these guys simply lucky?
#
Am I just getting impressed by these specific numbers?
#
Or is there something more to it?
#
Absolutely. Absolutely.
#
All that I'm saying is that from my perspective,
#
as an investor who has consistently beaten the index for well over a decade,
#
this has intrigued me that how have some stock market mutual funds done that?
#
And I find that there is a depth of thinking which has allowed them to do it.
#
And it goes beyond the law of large numbers.
#
So let's move on to a slightly simpler tendency, which is the availability heuristic.
#
Now let me define this for you.
#
The availability heuristic is the tendency to overestimate the likelihood of events
#
with greater availability in memory,
#
which can be influenced by how recent the memories are or how unusual or emotionally charged they may be.
#
What we also call the recency phenomena.
#
The recency effect, yeah.
#
And the poker example of this is that, and you'll often see the good players do this,
#
that a good player will get to the table and when stacks aren't very deep,
#
he'll play a little wild and he'll show down two or three bluffs.
#
So when he really has a big hand and the stacks are deeper,
#
he can extract a lot more value because his victim will just remember that,
#
oh, this guy has shown down a couple of bluffs and therefore he must be bluffing.
#
And that's the availability heuristic at work.
#
So, you know, this is what we call in the Hindi language of the businessman,
#
tezi mein tez aur mande mein manda.
#
I don't understand that, but it sounds great.
#
Well, what it means is that when stock markets are going up,
#
everybody thinks they're going to continue to go up.
#
And when they're going down, everybody thinks that they're going to continue to go down.
#
And one of the favorite stories around this is that when your shoeshine boy
#
starts giving you stock tips, it's time to get out.
#
So these are all manifestations of the same thing.
#
And seasoned investors know that there is this phenomenon.
#
And so you have someone like Warren Buffett saying,
#
the time to buy is when there's blood in the streets.
#
And this takes a certain courage of conviction
#
and knowing that you're not, for example, buying too early.
#
You know, seasoned investors are not too concerned about timing.
#
It doesn't mind being a few months off, a couple of quarters off.
#
But this is exactly what leads to boom and bust, is the recency phenomenon.
#
This is exactly what happened in 1999.
#
It's why if I sold Infosys at $6,500, somebody bought it.
#
And somebody also bought it at $10,500 and it never saw that price again.
#
It took 11 years to recover to that price.
#
And if you actually look at the numbers, you'll find that the maximum number of transactions
#
in that stock happened on the day on which its price was the highest.
#
That's the recency phenomenon in full flow.
#
Which tells you a lot and which actually takes us on to our next funda,
#
which is kind of related to this, which is the gambler's fallacy.
#
And that's defined as the tendency to think that future probabilities are altered by past events
#
when in reality they are unchanged.
#
I mean, the classic example of this is you ask someone the question that,
#
let's say I flip an evenly weighted coin and it comes 10 heads in a row.
#
And what's the probability that the 10th time will be a head?
#
And of course, as you know, it's 50% because the coin doesn't have a memory.
#
And the gambler's fallacy is like if you're at a roulette wheel and it comes red five times,
#
you say, oh, black is due.
#
Or you use the availability heuristic and you commit the same fallacy, but a different version of it.
#
And you say, oh, five reds in a row, it's a hot streak.
#
Next one is going to be another red.
#
Either ways, I mean, they're both sort of different sides of the gambler's fallacy,
#
but assuming not recognizing that every event is sort of fundamentally independent of what happened previously
#
and nothing or nobody is due per se.
#
Now, you know, it's like a poker context could simply be saying that, you know,
#
this time it's going to be a flush draw, you know, while the probability of hitting your flush draw is the same as what it...
#
Completely independent.
#
It's completely independent of what might have happened in the past.
#
And today my luck is not working.
#
You know, and so on and so forth.
#
Do stock market investors also show versions of the gambler's fallacy?
#
So, you know, in a sense, this is the obverse of the recency phenomenon, right?
#
And it tends to happen a lot less than the recency phenomena.
#
Because when we look at the stock markets, what we must realize is that if you look at the universe of investors,
#
people are only putting a fairly small portion of their net worth or their savings into the stock markets.
#
So what starts happening when the stock markets start going up is because of the recency phenomenon,
#
after a year or two of what we call a bull run, which is when prices are going up,
#
their wealth advisors, their wife, their uncle, their son start saying,
#
you know, there's so much money being made in the stock markets, you need to put more money in.
#
So more money starts coming into the stock market.
#
That money, given a certain restricted supply of stock, starts driving prices up.
#
So you start having more and more movement of money into the stock markets.
#
Now, because of the phenomenon of mutual funds, some of this starts becoming less fluid money.
#
It's more rigid money. It's more structured.
#
So in India, for example, we have this phenomenon of SIPs, systematic investment plan.
#
So what now happens is that a guy who's making a lack of rupees a month,
#
he tells his bank every month, you put 5000 rupees into this mutual fund.
#
That money starts becoming sticky.
#
And this means that the recency phenomenon starts to dominate.
#
And therefore, the number of people who actually start taking the opposing view is very few.
#
They're only the people who are outside of this. So you don't see too much of it.
#
You do because people will say, oh, you know, stock markets have been going up for eight years.
#
They've never gone up eight years in a row. Now they've got to crash.
#
So you do see some of that.
#
And I think that's equally lazy intellectually because you need to look at what's happening in the economy,
#
what's happening globally. There can be fund flows coming from abroad due to a whole variety of factors.
#
So you can't be lazy about it. There is this tendency.
#
All I'm saying is that this, to my mind, is not as important a fallacy in the stock markets
#
Right. And let's move on to sort of, I mean, we could just go on forever, but let's do that in our book.
#
We might do a follow up to this episode someday, a few months from now.
#
But for now, let's end with one more, which is a pretty powerful one, which is loss aversion,
#
which is defined as people's tendency to prefer avoiding losses to acquiring equivalent gains.
#
And the way I think of it is, you know, in poker terms,
#
it simply means that and every poker player will know this,
#
that losing X amount of money causes greater pain than winning X amount of money would.
#
And this is therefore something that even haunts profitable players
#
because I was throughout my time as a cash game player profitable month on month.
#
But being profitable in cash games typically means taking four steps up and three steps down,
#
four steps up and three steps down.
#
And the emotional pain of the three steps down is always much more than the joy of the four steps up.
#
And you can rationalize and say that, look, I'm profitable month on month
#
and these big losing sessions are inevitable and so on.
#
But yet they cause a lot of pain.
#
And, you know, in the stock market, this can, for example, make people risk averse
#
because they're scared of losing in there and so on and so forth.
#
So I'll tell you how this, there are many manifestations of these,
#
but let me look at the one which I find particularly poignant,
#
which is related to the point that I just made about people entering the stock market
#
because of the recency phenomenon.
#
And obviously the later they are into it, the less chances that they make money
#
because they could be coming in, they could be the guys who are buying emphasis at 10,500 rupees
#
just the day before the dot com bust happens.
#
What's really poignant about this is that if you look at a long enough term
#
in India, the stock markets beat any other form of investment.
#
They beat fixed deposits, they beat gold.
#
It's a little moot whether they beat real estate or not.
#
But they certainly beat investments in bank deposits, in fixed deposits or in gold.
#
What happens, however, is that if people enter late
#
because they are entering at the end of a boom phase, which is inevitably followed by a bust,
#
they say stock markets create losses and they exit
#
and it takes them, if ever, 10 or 15 years to recover.
#
So they have lost the opportunity to grow their net worth substantially over their productive phase,
#
which is 35 years of saving, catering for your retirement.
#
The answer is actually very easy, which is that you look at long term data,
#
you look at it objectively and you prepare yourself for losses.
#
You say that there will be a year or two when there are downturns,
#
but I'm getting into the market knowing that these downturns will happen, I'm prepared for them.
#
And when you actually discuss it with people in your family, you tune yourself to it,
#
there are people to remind you because it's not easy.
#
It's not easy as a fixed income earner to have put two years of savings into the stock market
#
and to see it lose 30 or 40 or even 50% as it happened twice in the last 10 years, 17 years, sorry, from 99 to now.
#
So you had the crash of 2000 and you had the crash of 2008.
#
So twice you could have seen your investments go down by 40 or 50, but it's not easy.
#
But if you've looked at the data, you've looked at the stock market as a way of creating wealth
#
over a career of saving and preparing, then you know that this is going to happen.
#
So you can inure yourself to loss aversion by the same method,
#
the same process of going back to long term data and saying this is not a casino.
#
I'm not betting on making money this year.
#
I'm betting on creating wealth over a long period.
#
I think beating these cognitive biases and becoming good at either poker or investing in stock markets
#
requires both a certain degree of self-reflection,
#
the willing to be critical of yourself and to recognize these so-called bugs in the machinery of your brain,
#
and a certain amount of hard work.
#
On that note, we'll have to put in some hard work to get our book together.
#
Thank you so much for coming on the show, Mohit.
#
My pleasure, Amit. I look forward to that hard work of writing.
#
The Scene in the Unseen is co-produced by Indus Vox Media Podcasts,
#
and you can check out other IVM Podcast shows on the RAPPOR website,
#
especially a new one called Akansha Against Harassment.
#
Hosted by Akansha Srivastava, this show discusses cybercrimes and how to make the internet a safe place.
#
For one, you can stop browsing and start listening.
#
Episodes out every Thursday.
