“We have met the enemy and he is us,” said a wise opossum named Pogo (not to be confused with POGO, the Project on Government Oversight, which is featured in my next book Train Wreck) in a 1970 newspaper cartoon written by Walt Kelly. Cicero put it in a more general context: “Man is his own worst enemy,” sometime around 50 B.C. It has been modified to say you are your own worst enemy. Ok. I think you get the idea.
No one will ever accomplish their investment goals, if they don’t first master their own emotions.
Let me just say at the forefront of this article; if you think you can be profitable in the stock market, without addressing your emotional makeup first, well, allow me to use another quote, “A fool and his money are soon parted.” I have seen the well-educated, the housewife, the retiree, the CEO, the business owner, and many others from all walks of life, forfeit their chance to make very good money. All were brought down by an overlooked nemesis known as emotions. I don’t care how great of an investment plan you, and your adviser have hatched. If you don’t learn how to identify, and corral your feelings, you will never be a successful investor. You will be doomed to walk in the land of meager returns, where CDs and savings accounts dwell. If you think these are “safe” investments, consider this: On average, the cost of goods double every 18 years, due to inflation. So, what costs $100 today, will cost $200 in 18 years.
Dalbar, a premier market research company, with one focus being in the field of investor emotions. How an investor behaves is more important to investing than you might imagine. I would venture to say it is the single greatest issue that determines investment success or failure. No one will ever accomplish their investment goals, if they don’t first master their own emotions. You can be the smartest or luckiest investor ever to walk the face of this planet, but one single emotion can completely annihilate any chance of making money from your investments. But we aren’t dealing with just one emotion; we must contend with two: fear and greed.
A twenty-year study conducted by Dalbar, revealed the number one factor directly affecting the amount of money an investor makes, is the investor’s emotional responses to the movements of the market. Consider this.
During the two decades spanning 1987 to 2006, the average investor achieved an annual return of 4.3% from his equity investments. In contrast, the unmanaged S&P 500 index achieved a return of 11.8% per year. That is a cumulative return of 236%! Remarkable! If a person had simply purchased an index fund, and held it for 20 years, she would have acquired double-digit returns on her money. Unfortunately, the average investor only realized a 4.3% gain, over the same time period. Are you beginning to get the picture?
Fear and greed are no laughing matter. If you cannot consistently defeat these two evil twins, your returns will suffer. Here is a breakdown of the disparaging gap between disciplined investors, and the herd. While there is no simple answer to this dilemma, there are some steps you can take to help move you from the red column to the blue one. Here are five to consider.
1. Know Your History.
William O’Neil, founder of Investor’s Business Daily said, “The American Stock Market has been growing since 1790. So, in my opinion, faith and confidence in America’s long-term future is a very shrewd and intelligent position to take and stick with for as long as you live.” The stock market makes more than it loses. Otherwise, the DOW would be at zero. There has never been a time in history, where the stock market did not recover from a downturn. When you recognize that markets move in cycles, and that history is on your side, you will make significant gains on controlling your emotions.
2. Consider the Source.
Ever since TV showed up at the 1939 World’s Fair, we have been indoctrinated with so-called expert advice on how to invest. There is a 24/7 stream of investment noise available to every American. Rutherford D. Rogers said “We’re drowning in information and starving for knowledge.” Louis Engel said, “The cheapest commodity in the world is investment advice from people not qualified to give it.” There is no scientific evidence which proves short-term price fluctuations are consistently predictable. Therefore, I encourage you to adopt a long-term view of investing. The Dalbar studies spanned 20 years, not 20 minutes.
3. Overcome Negative Experiences.
Samuel Case said: “Most investors try various markets, lose money, and finally acquire some knowledge through bitter experience. This is roughly analogous to learning how to drive by having a series of accidents.” A salty sea captain was asked by his first mate how he knew where all the shoals and reefs were in the bay. The captain replied, “by hitting them all!” That’s not what we would call a good investment strategy. If you have been a victim of your own behavior in the past, make a new resolution to approach your investment strategy, without letting your emotions control your behavior.
4. Find a Coach.
No one has the self fortitude to overcome fear and greed all the time. It only takes one moment of weakness to ruin everything. This is where a consultant can bring value to your investment strategy. Unlike brokers, who get paid a commission regardless of the outcome, an investment consultant makes more money when you do, and less when you do, since their income is tied to a percentage of your portfolio value. Find one who is a strong advocate of client education. Understanding why the market behaves the way it does, is empowering for the investor. You can make better gains if you will learn how to overcome your fears, and harness the destructive power of greed.