Back on the 12th of June, Harvard Business Review (HBR) published an article explaining how so many investors were enticed by Facebook’s public offering and why it wasn’t a good idea, according to their principals of investment, to jump on the investment.
The first point they raise involves small investors, and the mentality they took when evaluating the investment. According to HBR, there were many who rushed out and to open their first investment account just to take advantage of Facebook’s offering. They believed it was the next big thing and just had to be a part of it.
As many of us already know, and it is easy to say in retrospect, Facebook has already been around too long to be the next big thing. In fact, Facebook was the next big thing half a decade ago. So those operating under this premiss were already at least five years behind the trends.
Also according to HBR, many people believed it was a sound investment because of a psychological phenomenon commonly referred to as Availability Bias. They specifically reference a man who took $5000 of his own money, then borrowed another $5000 from his mother, and put it all in Facebook (this was all the money he had).
With the above imagery in mind, consider the definition of Availability Bias:
“Availability Bias: When confronted with a decision, humans’ thinking is influenced by what is personally relevant, salient, recent or dramatic. Put another way, humans estimate the probability of an outcome based on how easy that outcome is to imagine.”
Now this is a very reasonable explanation for the man’s mistake however, if you are making your very first investment, without the aid of a professional, it is just plain stupidity to invest your entire nest egg (savings), and part of someone else’s, in something you feel as a gut reaction, or shorthand to an informed decision.
Gut reactions are typically reserved for someone who has knowledge of the playing field and has learned a lesson or two.
Furthermore, it is very unwise, and probably violates the most elementary rule of investments, to take all your resources and bet them on one horse (one company’s stock). I think everyone knows, whether you’re investing $500 or $10,000, balance is the key.
For instance, If you have a lot invested in risky up and coming technology stocks, it is also a good idea to balance those investments with something mature, stable, and not likely to go away anytime soon.
When investors pull their money out of high-risk areas because of a huge loss, they usually funnel that capital back into stable investments, and can temporarily create gains in large, stable stocks. The whole balance theory.
The HBR does give some excellent advice in their article to help people with future investments:
* Focus on discovering customers’ needs. When you discover unmet customer needs, you naturally create a differentiated offering with true market value. Easy to say, but the trick here is to make sure you really are looking for customers’ needs — not just convincing yourself that customers need what you, or everyone else, want to make.
* Pursue a long-term strategy. In an effective strategy, short-term moves should be leading you toward a desired outcome in the long term. A collection of opportunistic bets, no matter how sure they seem in the moment, is not a strategy. Would any solid personal financial plan have advocated liquidating mutual and bond funds to bet the farm on Facebook?
* Don’t follow the herd. We’re all human, and there’s emotional comfort in doing what everyone else is doing. Recognize that feeling — and then make sure that you’re not letting it cloud your judgment. Be vigilant and actually evaluate each investment opportunity on its merits, not on its media profile.
These are great pieces of advice, but as I already alluded to, this type of thinking is more common sense, and probably not even remotely typical of savvy investors. Most people who play the stock market don’t expect to invest $10,000 one day and have $35,000 appear the next day; it’s not a get rich quick scheme.
Investments guru, Mark Cuban explained what he thought about the Facebook IPO, but it wasn’t an abysmal assessment as one might expect. He purchased huge amounts of Facebook shares as well, and he believes it was a wise investment.
His first point was to say that big investors always exploit stupidity on the market, because they know it always works. Essentially, financial firms use disinformation to manipulate market behavior. Experts predicted the Facebook IPO would have one of the biggest small investor turnouts in history, and it did. Big banks and Nasdaq hyped the hell out of it.
Mark Cuban comments on the Facebook IPO and shares of the company:
“Can you imagine how pissed you would be if you bought a boatload of Facebook thinking you got in at a better than IPO price only to watch the price on the open market post IPO drop below the price you paid in the private market ? Ouch.”
“The law of unintended consequences is that the dynamics for how private companies are valued and are able to raise Pre IPO rounds could quickly change if the prices and volumes on SecondMarket and its competitors declined significantly.”
“Valuation has no relevance what so ever. Conventional wisdom says the buyers of stocks will try to determine the value of a stock before they buy or sell and make the appropriate rational decision. Not even in a Richie Rich cartoon does that happen.”
“Bottom line, if you think mobile will displace online usage from PCs then you should immediately short Google and other ad plays and buy TV stations and networks. If you can’t buy an ad effectively on mobile and no one is using a PC to connect to the internet any more, then the only way to reach an audience is going to be via good old tv. And all that over the top video noise, forgettabout it.”
Cuban purchased a boatload of Facebook shares himself, but again, it’s not his only investment, and he’s not expecting all the return on his investments a week later. He believes it could end up being a valuable investment, but not because everyone he knows uses it.
If you are letting the availability of information already in your head replace good old fashion research, you’re selling yourself short. If you follow the herd when it comes to investing, you are probably headed where most herds end up. At the slaughterhouse.
It’s good to take calculated risks, but not blind leaps. Facebook may yet prove to be a valuable investment, but like all good things, it doesn’t happen overnight. Also, when prices are low, like Facebook shares are right now, it’s the time to buy, especially if you can afford the gamble.