1. Know Why You Are Investing
In your hands, you have the tools which, if you apply energy and focus, will help you to survive and even thrive in the investment markets. There are too many products offering specific investment advice but too few products out there to help you determine how to use the advice. There is a saying “Give a man a fish, and you feed him for a day; teach a man how to fish, and you feed him for life” . We hope that with this program, we are teaching you how to fish.
1.2. Knowing Yourself is the First Step
Investing is as much an emotional activity as a rational one. This is further complicated by the fact that different investors may have different underlying motivations for investing. In the art of war, Sun Tzu says “If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained, you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle“ . This is certainly a very good rule for investing. To have knowledge of ourselves – our emotional reaction to losses and gains and our true motivations – is essential to investment success.
1.3. Keeping Emotions Under Control
Emotions play a key role in one’s ability to maintain investing discipline. The timing of buying and selling shares may be affected by powerful emotions. The two most powerful emotions in investing are fear and greed. Other emotions, such as jealousy or envy, may also come into play, although these are cousins of greed. The problem with powerful emotions is that they may drive one to buy or sell shares at the wrong time. Each individual is a bit different in how these emotions play on their decision-making. Whatever your emotional make-up, it is critical for you to understand it.
Take the purchase of a company’s shares. Oftentimes, investors will jump into a company’s shares only after they have risen substantially. Emotions can drive such a decision in different ways depending on the person. For one person, jealousy that others are making money in a certain stock may drive them to buy the shares as well. For another person, fear of entering the stock market may subside when they have seen a share do well. Their comfort level may increase as a share rises when, oftentimes, the exact opposite reaction is more justified.
Similarly, selling shares can also be driven by emotions. Selling a share after it has fallen can often be driven by fear of losing more money, rather than a calculation that the company behind that share does not deserve its stock valuation. When a share has risen substantially and looks to be overvalued, an investor will often avoid selling the share out of greed, even if new information comes in which is materially negative, in the hopes that what has made money for him before will continue to do so.
No matter what, share prices have gone up and they have gone down. In the future, they will continue to do so and volatility in share prices should be expected as part and parcel of the activity of investing. Any investor should try their best to understand how they react emotionally to movements in share prices. This may take time and experience, but such knowledge can not be gained without taking the effort to observe one’s reactions to volatility. Such self-knowledge can help one to adjust investment strategies to give oneself the best chance for success.
As much as possible, investors should try to make buy and sell decisions on the basis of reasoning, rather than emotions. To the extent that emotions are constantly coming into play, investors may need to find ways to circumvent this self-defeating behavior. In some instances, investors may choose to stick with less volatile investments if they find that they have difficulty sleeping at night and that volatility is resulting in the investor making poor investing decisions. Another option for investors which may be hurt by their emotions is to follow a more systematic method of asset allocation. For instance, decide on a fixed allocation between bonds and stocks (say 50% stocks, 50% bonds) and when the ratio is more than 5% away from the target ratio then assets should be shifted. If the system followed is practical and makes sense, the investor can avoid short-circuiting his decision making process by emotions.
1.4. What Are Your Motivations?
Many investors will question how there could be different motivations behind different people’s reasons for investing. “Isn’t the sole reason to invest to make money?” one might think to oneself. This is often only a surface motivation. Here is a list of some of the other factors which may motivate one to try investing:
• Love of competition and “winning”.
• Wanting to join the crowd and a fear of “missing out”.
• Hope for a big score – the “lottery” factor.
• Need to feel important – “investing” sounds like an important activity.
• Need for attention – attention from brokers, etc.
Please examine the list and look deep within yourself to see if any of these or other motivations are driving you to invest. Having these motivations does not necessarily mean that one should not invest. However, having an understanding of these motivations will help one to better set goal and parameters for investing.
If the motivation is one other than to achieve better monetary returns, one should adjust one’s goals and the measurement of achievement of those goals accordingly. For instance, if the primary motivation is entertainment, then the success of one’s investing activity should be measured in terms of how much entertainment was achieved, rather than how much money was made. Similarly, if the goal is to hit a big score, then the types of investments may need to be adjusted to those which have a chance to show higher returns.
At the same time, an investor must also adjust the amount of her assets allocated to investments to a size appropriate to one’s motivations. Again, if entertainment is the goal, then perhaps the amount of money put at risk should be limited to the amount of money one is willing to spend on entertainment. The amount should not be raised to higher levels with the false justification that it is part of a savings plan, and therefore, “for a good cause” if this is not the case.
I have many friends that enjoy gambling in Las Vegas. These friends know the odds are stacked against them but continue to gamble because they enjoy it and see it as a form of entertainment – like watching a show or going to the movies. The key to gambling not ruining there lives, however, is that they do see it as entertainment and budget the amount of money they are willing to spend on gambling appropriately. In the case of the investor whose goal is to enjoy the feeling of making a big score, this investor should also adjust the size of his investments to that appropriate to the goal.
Chasing after a big score is likely to entail investing in all-or-nothing situations – perhaps a small pharmaceutical company with only one drug in testing which could make or break the company. In most cases, the amount of money allocated to chasing after the big score should probably be adjusted downwards relative to the amount devoted to investing for one’s long-term plans, such as retirement.
If an investor is not clear about the motivation behind their desire to invest, then perhaps patience is required. As time passes, one’s true motivation may become more apparent. Until you truly understand your real motivations for investing, it may be prudent to take a more conservative approach and/or limit the amount invested.