How To Invest With Imperfect Information
When investing, investors always have to deal with incomplete information. No matter how much or deep your analysis of a company goes, uncertainty will always still exist. As investors, how should we mitigate this risk?
Can we even have a successful investing record without perfect knowledge of the market?
Living in The Imperfect World
In investing, as with life itself, are never a sure thing. Since investing is about finding great opportunities in an ever changing landscape, the idea of having perfect knowledge about everything is a myth. Therefore, investors should try to get comfortable with the fact that we are never going to be able know everything.
Staying With Our Circle Of Competence
It is because we are working with imperfect knowledge in investing, we have to be discipline enough to stay within our circle of competence. This is the area where we have a reasonable level of confidence in understanding the industry and the companies we are analysing. The simple fact remains that if we are unsure about the decision that we made, we will be easily pressured when things did not go as we have planned. Imagine if you have invested in a company you did not know much about and have bought it simply because all your friends are telling you how great this company is and news is the share price will increase in the next few month. So, you buy it hoping that the share price will increase significantly. So half a year later, the share price of the company is down 30%, what do you do? Most people will hang on to the investment and hope that they will as least breakeven on it.
That is call loss aversion, the fear of realizing your losses. It is so common that there is a cliché stating “An (long-term) investment is a trade gone bad”. Now imagine if you hang on to your self-control and did not invest in the company, you would have not gotten yourself into the bad investment at all. Or you went back and did a through research on the company and realize that the company was indeed a great long term investment. You bought it and suffered the 30% loss, but at that point you can buy even more of the company if you still believe it is a great long term investment.
Value In Action
It is true, we will never be able to understand everything about everything. However, even in this imperfect information world, we must learn to only act when we have sufficient information.
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