According to Goodman, the stock market isn’t necessarily fully rational and investors need to gauge sentiment in order to discern the right timing to make an investment.
He said investors should be wary of analysts and experts as professional money managers are overrated.
“The market — investing — is the greatest game of all. Because investing is an exercise in mass psychology, in trying to guess better than the crowd how it (the crowd) will behave,” Goodman wrote in his book
The Money Game, published in 1968 which became an immediate bestseller and remains one of the top investing books of all times.
In the book, Goodman exposed financial complexities under the name of one of history’s most famous economists, Adam Smith.
Goodman started an institutional investor magazine in the 1960s and was the executive editor of
Esquire in the 1970s. He also hosted a popular show
Adam Smith’s Money World, on PBS from 1984 to 1997. He died in Miami in 2014 at the age of 83.
Contrary to popular belief, Goodman did not choose the pseudonym Adam Smith, after the famous economist. Rather, it was given to him as a young journalist for a New York magazine in the 1960s to hide his identity from sensitive Wall Street sources.
Market mood a major factor in determining stock value
Goodman felt there was a huge difference between whatever was written about the market and how it actually behaved. “It has taken me years to unlearn everything I was taught, and I probably haven’t succeeded yet. I cite this only because most of what has been written about the market tells you the way it ought to be, and the successful investors I know do not hold to the way it ought to be, they simply go with what it is,” he said.
Goodman said each investor perceived the value of a stock in a different way. He felt investors should view stock valuation as a range, instead of a fixed price.
He believed the factors that gave a stock a value and price came partially from the financial statement, and mostly from the mood of the market. “The mood is what makes a system, a theory, a strategy, or a rational view on markets imperfect, imprecise, sometimes wrong, and irrational. Mood makes markets biological, complex, and keeps them in a constant state of change,” he said.
Goodman used to say it is essential for investors to know themselves very well, and this could help them deal with their biases and learn from mistakes.
He felt investment decisions made by investors revealed a lot about their personalities. So it was better for them to figure out their biases, learn from them, and use them to their advantage, than ignoring them, fighting against them, and failing. “The first thing you have to know is yourself. A man who knows himself can step outside himself and watch his own reactions like an observer,” said he.
From his years of experience, Goodman made several observations about the market in his book
The Money Game. Here are some of them which are still relevant for modern-day investors.
- If you don’t know who you are, market is an expensive place to find out.
Investing could be quite costly as investors often succumbed to the stress and anxiety of the volatile market situations. Goodman felt investors who could show emotional maturity, remain calm, keep their cool, discipline and patience were the ones who could achieve success in the long run.
“The end object of investment is serenity, and serenity can be achieved only by avoiding the anxiety. To avoid anxiety, you have to know who you are and what you’re doing,” he said.
- The real test is how you behave when the crowd is roaring the other way
Goodman believed the real test for investors was when they have to act contrary to the crowd, as human nature suggests most people find comfort in being part of the crowd.
- Every bubble or euphoric period must start with a rational idea
According to Goodman, behind every bubble or euphoric period there is a rational idea. He said the story of the bubble spreads and the crowd’s herd mentality takes over till it eventually peaks after which every dip becomes a false buying opportunity.
- Each investor has a unique style of playing the investing game
Investors liked to play the game of investing for many different reasons. Only a few investors actually played for the money, but the rest of them played for the thrill and action, the image it presented, the sense of belonging of being in a crowd and for the stories to brag to friends and strangers.
Goodman believed each investor had a unique style of playing the game and each made up her own set of rules and had a different definition of winning. He said investors often changed the rules and the definition of the game multiple times depending on how well they were playing.
- Strongest emotions in the market-Greed and Fear
Goodman believed greed and fear were the strongest emotions in the market, as nobody liked to watch others make more money than them. He felt investors hated losing more than they liked winning.
Goodman said these emotions had a huge impact on investors’ willingness to change goals and time horizons. He felt investors were generally hesitant, cautious and timid at the bottom and bold, confident, and audacious at the top, which was the exact opposite of what was necessary for success.
“No matter what role the investor has started with, in a climax on one side or the other the role melts into the crowd role of greed or fear. The only real protection against the vagaries of identity playing and against the final role of being part of the crowd when it stampedes is to have an identity so firm that it is not influenced by all the brouhaha in the marketplace,” he said.
- The identity of the investor and that of the investing action must be coldly separate
Goodman felt the most brilliant investors also faltered if they started showing any sense of attachment or emotion to an investment. “The most important thing to realise is simplistic: The stock doesn’t know you own it. Nor does it care. Investing is the epitome of a one-sided relationship. Emotional connections don’t exist,” he said.
Goodman advised investors to remain detached as it would help them to change their mind or reverse course, without being tied down by prior decisions.
- Beware of goals identified by numbers
Goodman noted that sometimes investors set unrealistic goals and expectations from their investments which they often define by a big round number. He felt sometimes investors get so fixated on achieving this target that despite big gains, they try to hold on for a little more and end up messing up everything due to jealousy, envy, greed or dreams.
- Nothing works all the time and in all kinds of markets
Goodman believed sometimes investors need to sit tight due to market uncertainty, stay patient and not do anything at all till the times get better. He was of the view that taking a decision to not make a decision was a big decision in itself.
“If you really love playing the g, any action is better than inaction, and sometimes inaction is the proper course, if it has been taken after measuring all the measurable options. If a decision is made not to make a decision, that is just as much a decision as a decision which initiates action,” he said.
- Be wary of high growth companies
Goodman said high growth companies carry the seeds of their own destruction as their USP often gets copied by other rivals and peers. He said growth gets spread across competitors and prices get cut as companies battle for market share, and profit margins suffer.
- Best to concentrate on a few stocks only
Goodman said that although investors diversify their portfolios to cut out the risk associated with market volatility, they only end up in getting average returns. Instead he felt investors should concentrate their portfolio with only a few stocks with outstanding potential.
“Sweet are the uses of diversity, but only if you want to end up in the middle of an average. By concentrate I mean in a few issues only. There are, at any one moment, only a few stocks that have a maximum potential, and I, for one, am not smart enough to be able to follow more than a handful of stocks at a time. If you are concentrated in only a few stocks, you are forced to measure each of them in terms of potential against each new idea that comes along, and this in turn makes you bump the bottom stocks off — the worst-performing ones — to take aboard something more promising,” he said.
- Don’t be over-dependent on mathematics
Some investors showed over-dependence on mathematics, accounting numbers and figures, which inject an expectation of precision in the market that is hardly ever accurate.
He felt that the more complex the math, the more speculative were the results. Goodman said although accounting standards and financial statements implied precision, yet sometimes earnings could be manipulated in many ways so investors should remain careful.
According to Goodman, almost every investor takes the accounting numbers at face value and rarely spends the time to look beyond the image the management wants to project. They hardly are able to spot why and what’s being manipulated, and what are its implications, he felt.
- Biggest risk to fund managers: Career risk
Goodman was of the view that the biggest risk that a fund manager faced during his tenure was career risk. He said most fund managers were not willing to bet their jobs by looking wrong in the short term, even if looking wrong produced great results in the long term.
“The market does not follow logic, it follows some mysterious tides of mass psychology,” he said.
Goodman felt new investors were more susceptible to falling prey to the mass psychology as they’re too young to remember any bad times or are yet to face any major setback in the current market scenario. So these new investors get attracted to the new math and the new market trend.
- It is essential to own stocks with great value before others
Goodman said it was important for investors to own the stocks that they felt were going to be of great value in the future before it got noticed by others.
“The most brilliant and perceptive analysis you can do may sit there until someone else believes it too, for the object of the game is not to own some stock, like a faithful dog, which you have chosen, but to get to the piece of paper ahead of the crowd. Value is not only inherent in the stock; to do you any good, it has to be value that is appreciated by others… If you are in the right thing at the wrong time, you may be right but have a long wait; at least you are better off than coming late to the party. You don’t want to be on the dance floor when the music stops,” he said.
- Market reflects a nation’s well-being
Goodman said although the market is only a tiny part of the society, it reflects the general mood of the people so it is a good litmus test for knowing the current performance of a nation.
“Markets only work when they believe, and this confidence is based on the idea that men can manage their affairs rationally. In the long run, the actions of all the investors, individual and institutional, professional and nonprofessional, have to be based on the belief that leadership knows what it is doing and that rational men are handling the nation’s business rationally. If that belief fades, then so do the markets. They do not merely dive, they dive and then they disappear,” he said.
- Win the investing game to become rich
Goodman said in order to become rich, one needs to win the game of investing by earning wealthy returns on their investments.
He said each investor has a different definition of what being rich actually means to them. Some investors treat it as a possession and compete for it to see who can collect the most. But the wise and rational investor knows that being rich is actually about having the financial freedom to enjoy life.
(Disclaimer: This article is based on George Goodman’s book The Money Game
, and his various interviews.)