Your 7-Minute Guide to Making Better Investment Decisions

Investing, in its simplest form is about finding investment ideas, analysing companies and making decisions. Your investment returns can be improved by improving any one of the three activities. In this article I want to give you some ideas on how to improve your decision making. It is something I started a few years ago that has helped me immensely. Give it a try. It may not only, improve your your investment returns but other areas of your life as well.

I have always been an avid reader of anything written by Peter Drucker (1909 – 2005). His ideas on business and management has always been miles ahead of current thinking. At least once a year I try to read an article he wrote called Managing Oneself which is an excerpt from his book excellent book Management Challenges for the 21st Century. In the article Peter describes a technique on how to discover your strengths through the use of feedback analysis.

“Whenever you make a key decision or take a key action, write down what you expect will happen. Nine or 12 months later, compare the actual results with your expectations. I have been practicing this method for 15 to 20 years now, and every time I do it, I am surprised.

The feedback analysis showed me, for instance-and to my great surprise-that I have an intuitive understanding of technical people, whether they are engineers or accountants or market research-ers. It also showed me that I don’t really resonate with generalists.

Feedback analysis is by no means new. It was invented sometime in the fourteenth century by an otherwise totally obscure German theologian and picked up quite independently, some 150 years later, by John Calvin and Ignatius of Loyola, each of whom incorporated it into the practice of his followers.”

I have successfully used this technique to evaluate and improve my investment decisions. Each time I make an investment I write down the answers to the following three questions:

1. What is my reason for buying?
2. What is the security worth?
3. How did I calculate this value?

Don’t write a long story just one or two lines. As I have found that, the longer the reason for buying (the more complex the investment case) is the lower my returns usually are. The simplest investments arguments are usually the most profitable. When I review the investment in my portfolio, after a price decline or receipt of new information, I look at the reason for buying. If the reason is no longer valid I seriously consider selling.

Also when selling an investment I refer back to the purchase decision and add the return on the investment (in total and per year) as well as the reason for the profit or loss. Every six months I compare my decisions with the results. A profit does not automatically equal a good decision. A good decision would be one where the reasoning behind the decision proved to be correct. Was your thinking process that led you to the buy decision correct?

For example a profit made through a completely unexpected buy-out of the company would not equal a good decision whereas buying because you thought a security is undervalued and then profiting from a buyout would be a good decision (the undervaluation made the company an attractive buy-out candidate). I urge you to give it a try, you will be surprised at your findings.

I for example found that:

I am a very bad coat tail investor i.e. buying a security because someone else bought it. I am uncomfortable holding the investment and tend to make bad sell decisions. Either too soon or too late, after a gain has evaporated. Also, if I do too much analysis on an idea I lose my objectivity. I tend to fall in love with the company and tend to see price declines as a reason to keep on buying. Something that has cost me dearly.

That said I am still not 100% sure what my correct amount of research is. But I am sure I am moving in the right direction. Using check-lists as I described in the article What does your checklist look like? is a step in the right direction for me. I also add securities I have sold to to a virtual portfolio as I realised that I often sell investments too soon. I review this “sold” portfolio six monthly to evaluate the quality of my sell decisions. I do this for only up to a year after the investment has left my portfolio as thereafter the investment case may have changes and I have stopped following the company. This has helped my returns a lot as it has, objectively, confirmed my mistake of not letting winners run.

In summary

We make hundreds of decisions every day, some more important than others. If the quality of important decision in our lives can be improved, even only slightly, it can make a huge difference. This is of course also true of your investment decisions. I urge you to put a system in place to improve your decision making. It will show great dividends in your life sooner than you would expect.