Most investors strive for excellence when they enter the market, building a sense of confidence that they believe will do well for themselves. Unfortunately, too few of them focuses on the negative aspect of the knowledge that is so critical to become a successful investor.
The concept of negative knowledge is about experientially acquiring knowledge about what is wrong and what to be avoided during performance in a given situation. In short term, it is to learn from the mistakes investor made and avoid a repeat of them in a crucial situation. A common misunderstanding is that negative knowledge is deemed as bad, poor and disadvantageous because of what is being described literally. But because everyone is liable and prone to making mistakes at some point in our lives, and just because negative knowledge is non-viable in certain situations, it is not necessary worthless or superfluous.
Negative knowledge can in fact be much more powerful than positive knowledge because cutting down on unforced errors on either investing behaviors or decisions can determine the long term returns of our portfolio. It does not necessarily mean that we will avoid making such mistakes. But given the idea that making enough good decisions over time and cutting down on those unforced errors will enforce the number of winners and probability of success in your portfolio.
Take a tennis match for example. When an average player is playing a top seed player, his probability of winning the match is usually higher when he cuts down on the unforced errors rather than playing for winner shots, and at the same time hope that the top seed player is having a bad day and making more than average unforced errors. The same goes for investing. When we cut down on the silly mistakes we know we are prone to making, we come up better and stronger.
Let’s now take a look at some examples of those negative knowledge we tend to acquire:
1.) Collective Rationalization (Herd Investing)
I’ve written an article previously on the subject matter explaining my position regarding herd and crisis investing (original article) in greater detail.
Herd investing is usually a recipe for disaster.
The herd investing mentality allows the tendency to think that whatever the behavior or decision the group made must be coherently correct because there are multiple minds think alike. Time and time again investors fall for this sort of rationalization because they think that strength is power and they are in a much comfortable running away from the fire instead of being a firefighter contrarian. If you are interested to read my original article on the firefighter contrarian concept, you can read it here.
Following the herd is what caused investors to accumulate into the technology stocks during the dotcom bubble, real estate during the great gfc and chinese stock during the recent manic run. What happens to the market after that, we will (had) already know(n).
2.) Not Having A Plan
This is a hard one because it’s a huge narrative concept that is open and can range from almost anything else.
The first and foremost is to have a plan on portfolio allocation, including how much are you willing to allocate for emergency funds, warchest, stocks or bonds. I didn’t start rationalizing the importance of this when I started investing until recently when I found out the utmost importance of doing so. Going top down regarding portfolio allocation is usually the safest method to ensuring that one doesn’t over / under invest unnecessarily in any products at any single time.
Next is to have a strategy on the types of investors you are willing to be and most comfortable with. Some are more comfortable with dividend investing strategy or others may be more willing to adapt the asset based strategy. Regardless of the type of investors, we need to ensure that we have a plan in place to execute our strategies in the market well.
3.) It’s Not A Matter of If but When
The worst part about investing is that it is going to be inherently slow, especially if you aim to become a successful investor. Most people are thrill seekers and they ended up in the bottom of the bin soon after.
Markets have been known to have its dark days and as investors, we need to acknowledge that it is only a matter of time that we will all be sunk in the dark pool of bloods when things get rough. During this period, successful investors will be able to survive and pounce on opportunities while the tide will wipe away the rest of weak investors who have been swimming naked.
To quote Sir John Templeton, he said “To buy when others are despondently selling and to sell when others are euphorically buying takes the greatest courage, but provides the greatest benefits”.
Perhaps the next time you see new investors lurking for advice, you might want to tell them to prioritize on the negative knowledge first before dreaming for the big glory of winning the capital market system.
What about yourself? Do you think prioritizing on negative knowledge is important?
Great post thanks! Psychology is very important in investing!
Thanks MW 🙂
I agree and would go even further and claim that the human refusal to say "I don’t know" has huge consequences, for example, not getting good returns from your investments in the stock market. There is ample evidence of a strong correlation between knowledge and humility.
As such, the best investors are those who realize how little they know.
And what really gets us into trouble is not even knowing that we don’t know.
Hi Tacomob
Thanks for your comment.
Humility is a great factor that many bloggers did not talk about and I think it has great consequences on every aspect of investing. It's very difficult to achieve perfection from all angles of the human behavior.
We will learn best from our own costly big mistakes; but it is better and cheaper to learn from others with our open mind and wide open eyes.
The problem is that we can trust but how to verify?
Some time it is worthwhile to verify it privately with your trusted ones and we may get the unexpected. Private conversation is not the same as public conversation. 🙂
Hi Uncle CW
Private conversation is personal, that's when every details come out. Public is much more general, as it caters to the general idea 🙂
I read somewhere today that every week, there is a new billionaire in China. That's some crazy number. China market is in correction, I'm sure at some point it will stabilize.
I guess, when buying something, one need to have some validation. However, with stock like FB or Twitter that are really isn't selling anything, produce very little profit, yet, they are Wall street's darlings. 🙂
Of course Mark Zuckerburg is smart, he'll probably find a way to sustain FB price, and keep the investor hope that he can do something with the massive data that he's collecting.
Hi Vivianne
The Chinese goverment is giving all the businessmen plenty of assistance to make it rich and grow the gdp of the nation. Given the huge population state and demand of the country, it's inevitable that it is playing catch up with the US but sustainable or not is another story altogether 🙂
Obama and the Republican have pushed the new trade bill with 11 other countries has left China out completely. I'm wondering how that would effect China. Posibly push China – Greece – Russia – Iran together if Grexit really is happening this weekend.
Hi B,
I believe we do not prioritise negative knowledge bcos we always start off as thinking positively and expecting good results in general. eg u do not start investing the first day and think that tmr u r gg to lose n be happy!
I think it's more like exposing ourselves more and if negative things happened, we learn to accept! Not sure how many people can accept negative things graciously!!!
Then convert the negative to positive knowledge over time via experience! It's great to learn from other people's experience. But what so great about life when we do not have our own experience?
Due to our inborn self-serving bias we associate our financial success with skill and our financial failures with bad luck or the "unfair" market.
It is better to learn from our mistakes rather than to pretend we haven't made them.
This one is quite true: "A man must be big enough to admit his mistakes, smart enough to profit from them, and strong enough to correct them." – John C. Maxwell
I believe if we can learn to avoid mistakes in the same way we learn to avoid warm diapers, we would have made huge progress in avoiding dumb mistakes with money.
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