The Wall Street Journal recently ran a pretty interesting article titled Investor, Know Yourself. The article focuses on the touchy-feely aspects of investing, which are as important as the fact-based aspect of investing. Investing is a combination of sound analytics and a sound mindset which will keep you from panicking or by letting your emotions govern your buy and sell actions. Unfortunately, as much as you may deny the influence your emotions have on your investment decisions, emotions always lurk, either blatantly or subtly behind the scenes.
For example, deeply buried fears can make you intensely risk-averse and keep you from taking even moderate and acceptable levels of risk that help your portfolio over the long run. The emotion of regret can make you abandon sound investing strategies that perhaps did not work the first time around.
It's important to understand your investment personality. Here's how:
# 1: What are you prepared to lose?
Answering and understanding this question basically helps you develop your risk profile and understand what you're willing to lose for certain amounts of gain. For example, if you reinvested all your assets in a new portfolio that gave you a chance of improving your standard of living by 50% or reducing it by a certain amount, how much reduction would you be willing to accept? 10%, 20%, 25%, 40% or 50%? If you pick 25%, you're essentially thinking that the pain of 25% can be counter-balanced by a 50% increase in your standard of living - basically that the pain of a loss is twice as much as the joy of a gain.
So, I urge you to assess this gain/loss ratio for your specific case... and understand if your fear of loss is overly driving you away from safer, more established companies (as during the financial crisis in 2008) or overly pushing you into risky stocks (as during the dot-com bubble in 1999) - it cuts both ways. If you're overly risk-averse, confront your anti-stock tendencies and pick those stocks that are safer, large-cap stocks to help you slowly get over your fears. If you're too much of a risk-taker, consider adding bonds to your portfolio and consider holding on to stocks for longer-periods of time to counter-balance your innate risk tendencies... and please remember that neither extreme is good - try to slowly moderate your risk profile without completely going against your grain.
#2: See how you react to the following statement:
"Whenever I make a choice, I try to get information about how the other alternatives I didn't chose turned out and feel bad if another alternative has done better than the one I chose."
Did that statement:
- Describe you well
- Describe you somewhat
- Not describe you at all
It's good to get information about how the other alternatives turned out and analyze them to see what went wrong - perhaps you picked the wrong investment and from that experience, learned how to get better at choosing your investments the next go around. Or maybe you picked the right investment but your strategy did not play out due to factors that were not publicly-known when you did your analysis, or because you sold too soon.
And it's only human to feel bad, so don't deny yourself that little emotional cry... but don't let a bad choice bug you - do your analysis, learn your lesson, sulk a little but then move on braver and wiser.
Remember Warren Buffett said that he lost billions by NOT investing in Wal-Mart, because he waited for the price to move 12 cents lower in order to buy it. 12 cents cost him billions. I think he learned THAT lesson!
Moreover, surveys show that women and the young tend to be more regretful than men... so if you're a woman or young, don't shy away from making certain investments in the future just because something just did not work out the last time. And don't regret wise choices that unfortunately turned out poorly... else you could miss out on future wins.
As Mark Twain put it:"The cat, having sat upon a hot stove lid, will not sit upon a hot stove lid again. But he won't sit upon a cold stove lid, either."
Make sure you aren't the cat in this little fable.
#3: Now pick which of the following statements best describes you:
- I strongly believe that I can pick stocks that would earn higher-than-average returns.
- I somewhat believe that I can pick stocks that would earn higher-than-average returns.
- I don't believe that I can pick stocks that would earn higher-than-average returns.
Did you know that men and the young are more risk-takers than women and the elderly? Men and the young tend to choose A - strongly believing that they can pick stocks that would earn higher-than-average returns. This is considered by psychologists as classic over-confidence tied to higher risk-taking and likely sub-par portfolio performance, This underperformance occurs because over-confidence results in more trading, under-analysis and "drinking your own Kool Aid". Investors that do beat the market over the long run, like Warren Buffet and Peter Lynch - do so by looking for great stocks at good prices and holding them for the long run.
So, for today, I will stop here with the three points mentioned above from this excellent Wall Street Journal article and share more points with you in my next blog.
Happy 4th!