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In an interesting article in the Washington Post, Michael Rosenwald makes a curious test case of himself in the increasingly popular study of behavioral finance (thanks, Dave):

Four months ago, judging myself to be the next Warren Buffett, I logged on to my Charles Schwab account and did something that in hindsight was astonishingly stupid, even for my own very long roster of financial screw-ups. I clicked over to the trading page and bought shares of Citigroup.

The company, like most of the big Wall Street banks then staring down the subprime meltdown, was limping along. The headlines were bad. The chatter on CNBC was pessimistic. I saw a bargain. I saw a company whose credit card bills and offers show up in millions of mailboxes every day. Just as soon as the banks got their write-offs out of the way, optimism would return to the sector. There would be more buyers of the stock than sellers. I would profit.

Now here I am today: My investment is down 22 percent. And I’m still holding on to the stock. Am I, as my wife and closest friends sometimes insist, the dumbest man walking the Earth?…

Earlier this week, I logged in to my Schwab account. I sold my Citigroup shares, at a loss. I’m going to push the money into an index fund. The move felt bad, no doubt about it. I didn’t fix what was in my head, but I did fix what my head had done.

While Rosenwald does a good job of summarizing Kahneman’s Nobel-Prize-winning theories in the article, what he completely ignores, however, is one of the most powerful drivers of market prices: sentiment!

His sale of the Citigroup stock had nothing to do with his original thesis for buying it and everything to do with feeling like the “dumbest man walking the Earth.” So rather than taking advantage of negative sentiment towards the stock (his original buy thesis), Rosenwald simply becomes another victim of it.

Rosenwald quotes Kahneman saying, “Individual investors have no business at all thinking they can do better [than average].” And I absolutely agree that overconfidence is detrimental to successful investing. But, rather than listen to Kahneman, an academic with no real investing success under his belt, I believe investors are better off taking Tom Basso’s advice.

How Thinking Costs You
Michael S. Rosenwald
The Washington Post
May 25, 2008

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