Two Ways of Picking Winners

By TAN Kee Wee

(MediaCorp 938LIVE’s Money Talks, Thursday, 20 August 2009, 7.50 am and 7.20 pm)

This weekend, over 80 young women will compete to see who is the fairest at the Miss Universe beauty pageant in the Bahamas. In this contest, the winner will be decided by the opinions of a handful of judges.

In some other contests, the beauty queen is decided by votes from the audience. It’s something like the Singapore Idol competition. If you are in the audience, you will vote for the girl who has the attributes you think are most important.

For instance, if you think that girls with curly hair are prettier and smarter, you would vote for the curly-haired girl. And if everyone thinks the same way, your preference would be the winner.

Usually, in such a beauty contest, there is another, second contest going on with the bookies. In this second contest, the prize goes to the person who picked the girl whom the audience has voted as the next Miss Universe.

If you participate in this second contest with the bookie, you can do one of two things. You can vote for the curly-haired girl, because you like girls with curly hair. But letting your preference dominate would be the wrong move.

The right move, if you want to win the prize from the bookie, will be to think what the audience’s perception of beauty is. Let’s say that the audience prefers girls with straight hair. Then, you should ignore your preference and vote for the girl with the straight hair.

Investing in the stock market is like this. If a stock price is going to rise, there should be enough people who are willing to pay a higher price than the price you paid.

This situation was highlighted by John Maynard Keynes, one of the most prominent economists of our time.He used the idea of a beauty contest to explain stock market price movements in his famous book “The General Theory of Employment, Interest and Money”.

Basically, a stock investor can choose to buy one of two types of stocks. Either he buys the stock which he thinks has the best value, or he buys the stock which all other investors think have the best value.

Needless to say, the smart investor must ignore his own preference, find out what the public perception is, and buy the stock which others think have the best value.

This behavior explains why in a bullish market, speculators are willing to pay crazy prices for a lousy stock or property. They know it isn’t worth that much. They would be stupid to buy it. But if they believe they can find a more stupid person to buy it, they’ll take it now.

Of course, this behavior of first checking what others think before we pick our winning investments cannot always apply, nor do we want it to apply always.

For instance, when we buy a home, it’s good to look at its investment potential. But this aspect can be ignored if the home is near the in-laws, or it’s near the office. This thinking doesn’t make us lousy investors, especially when the winners we pick fall into a different investment class.

Let’s take an example. When we choose a spouse, we choose the one with the characteristics we want. There is no need to check whether others find your potential spouse more desirable. Because, down the road, we are very unlikely to make money selling the spouse.

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