My Personal Finance Journey

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Whitney Tilson: Applying Behavioral Finance to Value Investing

Contributed by mm | July 31, 2006 7:21 AM PST

For those of you who have the passion of managing your own investment, I'm recommending a quick lesson on behavioral finance provided by Whitney Tilson, fund manager and investment columnist.

What is behavioral finance? In short, "Behavioral finance attempts to explain how and why emotions and cognitive errors influence investors and create stock market anomalies such as bubbles and crashes."

Out of my $400,000-strong portfolio, I'm investing about a quarter of the funds directly in individual stocks. I have been picking stocks since April 2000, soon after I cashed out my first batch of employee stock options (and coincidentally when the Great Bubble started to burst.) I consider myself in the value investors' camp. In the past six years, I recorded an accumulated capital gain of $7,000, or 9.2% annualized return on my invested capital. (It is actually not too bad considering S&P dropped from 1,498 in 2005 to 1,270 today.)

Over the course of the six years, there are many transactions I regret. Sometimes I bought high; sometimes I sold low; sometimes I jumped into sophisticated investments tool without knowing what i was doing; sometimes I didn't pull the trigger when a buying opportunities presented itself.

Over the time I realized I became the victim of my own emotions, and got a sense of guilty for my imperfection ... until I discovered behavioral finance, with which I understood I was just making some mistakes a normal human being makes every day. And more importantly, if I can reduce such mistakes, I can win the competition. I'm not saying I no longer make mistakes, but having something like Tilson's introduction deck as a checklist before any emotion-driven transaction will certainly help my batting average in the next six years.

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