Emotional Investing

Ask someone why they invest in the market and they’ll probably say “to make money… duh!”. But could there be other factors at play?

This week, I watched the film ‘Betting On Zero’ on Netflix. This documents the ongoing war between activist investor Bill Ackman and Herbalife, a multi-level marketing company that develops and sells nutritional supplements.

For those who don’t know the story, Bill Ackman famously took up a $1 billion short position against Herbalife and claimed that they were operating like a pyramid scheme. Ackman said that the majority of Herbalife distributors make little or no money and the company’s sales are propped up through minimum purchase orders. He believed that by publicizing this, the U.S. government would start investigating Herbalife and eventually crack down on them, sending the stock to zero.

That attack on the company sparked a very public spat between Ackman and then CEO Michael Johnson, as well as hedge-fund manager Carl Icahn. After Ackman revealed his short, Icahn actually took up a large stake in Herbalife. Icahn is known to be a shrewd investor and his interest in a company usually sends the stock up. It appears in this instance, Icahn was hoping to force Ackman to “cover his short” and lose a lot of money in the process.

Besides being a great film that delves into the rivalries that exist on Wall Street, ‘Betting On Zero’ also brought up a lot of good questions about our attitude to investing.

Why do we do it? What are our goals? And how do we react when the market turns on us?

Ackman states throughout the film that his move against Herbalife is not about financial gain. He genuinely believes that Herbalife is an evil organization that needs to be taken down and refers to his trade as a “good for America short”. To remove any doubt of his motives, he claims that he will donate any personal profits from the trade to charity. When pressed on the fact that he is investing other people’s money, he claims that destroying Herbalife is good for American business and therefore good for his investors.

Conversely, Icahn says that his bet on Herbalife is simply taking the opportunity that Ackman has provided to buy up stock in a great business. However, listening to the interviews, you can tell that there is something far more personal in it for Icahn—he just doesn’t like Ackman. The two have an ongoing rivalry running between them and this is his opportunity to hurt him.

Financial gain seems to have taken a backseat in the heat of these audacious investments (although Icahn might argue that). It sets up a dramatic head to head with Ackman and Icahn both vying for Wall Street’s confidence in their respective calls.

But it begs the question—what is your fundamental purpose in investing?

Utilitarian, Expressive, Emotional

Ask most people this question and the answer will usually be to make a lot of money. That’s fair. We all want to make a lot of money. But when you dig deeper, you might find that people end up acting in a way that totally defies this.

For example, pretty much every study on the subject has shown that the more you trade, the less likely you are to beat the market. But this information doesn’t stop people from trading more and more. Do they just think they will be the exception to the rule? Is there something else driving them?

Or why do investors sell stocks in companies that have over-performed and then reinvest in their losers? Some would call this “rebalancing”, but others would say it’s “throwing good money after bad”. Is it because giving up on an underperforming stock is kind of like admitting defeat, whereas reinvesting gives you the possibility that you may have been right all along?

Dr. Meir Statman, a finance professor and author, wrote that when it comes to purchasing (both financial and non-financial assets), there are three benefits people are looking for—utilitarian, expressive, and emotional.

Utilitarian is what we were talking about before. You invest in stocks to make money, the same way you buy a car to get you from A to B.

Expressive is a bit more complicated. You don’t buy a Lamborghini just to get you places. You buy it because it says something about you and your status in the world. On the other hand, you might buy a Prius because it says a lot about your environmental views.

Finally, the emotional is all about how that purchase makes us feel. Does it make you feel holier than thou to drive a Prius? Does it make you feel like a big-shot owning a Lamborghini?

Photo by Matt Wildbore on Unsplash.

When we think about these considerations in terms of stocks, we might find that some of our choices are not as clear cut as we first thought. We might think that we are investing in order to make money, but maybe there are more expressive and emotional factors at work.

Digging Deeper

Investing can be a fun endeavor. It can be intellectually stimulating to try to get your head around a particular company or industry. It can be challenging to try to beat the market year after year. We might treat investing like a hobby… or worse, a game.

From an expressive point of view, we may like to boast to other people that we’re investors —someone with more intellect and more disposable income than that of our neighbors and friends. And when it comes down to individual stocks, we might also find ourselves drifting away from our stated goals. Depending on your beliefs, you may choose to invest in some companies purely because of what they represent and not their ability to bring a return on your investment.

At Rubicoin, we believe that companies with good company culture and with happy employees that act socially responsible will outperform over the long run. That’s why our recommendations lean towards those kinds of stocks. In that sense, we are looking for companies that have this utilitarian purpose.

We also believe that people practice better-investing behavior with companies that they feel passionate about and respect. They typically don’t sell too early or get freaked by minor downturns. They are more willing to focus on the long-term.

However, that’s not a view taken by everyone, and as an investor, it’s yours to dismiss if you wish.

Near the end of the movie, Ackman, who is down around $400 million at this stage, gives a presentation on Wall Street which he believes will be the death blow to Herbalife. After many hours detailing what he believes to be dishonest and shady tactics, the crowd seem unmoved. The stock actually then rises 20% to a six-year high.

“People on Wall Street don’t care if the company’s a pyramid scheme. All they care about is the stock price in the short term”, Ackman says.

For each of us, it’s our choice on how we invest. Just be sure to consider what’s driving that choice.

 

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One response to “Emotional Investing

  1. Hi Rory, I appreciate this article and your insights about emotional investing. Investors have personal choices as to why they invest either they want to take down an enemy or just gain money. The story you’ve shared shows the irony of publicity. Bad or good it is still a publicity.

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