Obituary — Mr. Common Sense

Zoomer | May 30th, 2008

Here is an interesting illustration of why many people become frustrated with investing and then abandon well-thought-out strategies for either safety or high risk.

This little story uses the characters from Benjamin Graham’s famous book “The Intelligent Investor”:

Today we mourn the passing of a beloved old friend, Mr. Common Sense. Mr. Sense had been with us for many years. No one knows for sure how old he was, since his birth records were lost long ago in the bureaucratic red tape of government regulators.

He will be remembered for having cultivated valuable lessons such as:

* be patient with your investments

* don’t determine your future by looking in the rearview mirror and

* life isn’t always fair

Common Sense lived by simple, sound financial policies: don’t spend more than you earn; and reliable parenting strategies: adults, not kids, are in charge.

Unfortunately, his health began to deteriorate rapidly when well-intentioned media, friends and family decided it was easier to give broad and easily misconstrued advice on investing. We continue to hear reports from the media, who have obviously forgotten the investment lessons taught by stock market crashes and booms.

Mr. Sense began to forget not to over concentrate in the hottest investment product or sector. He lost track of the rule that diversification does not mean overweighting in one currency, one asset class, one geographical region or one investment style. All this combined to worsen his condition.

Mr. Sense declined even further when he was lured by the increase in the Canadian dollar and completely overlooked the fact that many of the world’s largest companies are American and do a large percentage of their business outside of the United States. He failed to realize that this increase in the Canadian dollar is a rare event not likely to repeat itself.

Common Sense finally gave up the ghost after he started to shift from his well-structured managed investment portfolio to either play the markets AFTER they achieved high gains — much like the internet market craze in the late 90s, or move to safety after they have fallen, a phenomenon that we are seeing right now. Common Sense was predeceased by his parents, Truth and Trust, his wife, Rational; his daughter, Responsibility; and his son, Reason.

Not many attended his funeral because few realized he was gone.

The Moral of the Story

This story demonstrates the fact that many investors continue to seek the holy grail of investing, without realizing that they may have already found it. Some feel that when faced with a period of poor performance, no matter what the cause, the best action is any action. However, it has been proven that a portfolio without structure is one without success.

Fear versus Greed

Many people manage their investments, based not necessarily on sound investing principles, but on the “Fear/Greed Principle”. This principle causes investors to react differently to various market conditions. Some are driven more by fear and others more by greed. You should recognize which type you are and discipline your behaviour accordingly.

EXAMPLE:

Scenario A: You put $10,000 in a wellresearched investment, and due to market conditions (let’s say the fall of the US dollar); the value of the investment falls to $8,000.

Scenario B: You put $10,000 in an investment that is at full value, and due to market demand (let’s say the Canadian Resource sector is hot), the value of the investment increases to $12,000. In which investment should more money be invested: the good investment that is down (fear) or the fully valued investment that is up (greed)?

The average investor usually sides with greed. Unfortunately, human nature is like this. In many cases, the more an investment increases, the more risk you are taking with your capital, and the more an investment declines (all things being equal), the less risk.

Intelligent investors do not let either fear or greed become an issue in their investment process. They have a well-thought-out investment strategy, which they apply each time they make a decision. They balance risk with reward and try not to let their emotions dictate their financial success.

Although it is easy to talk about these principles, it is difficult to actually follow through. It takes discipline and patience, which, with the apparent demise of common sense in the investment world, are hard things to master.

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