Investments are about as misunderstood as a grounded teenage girl who stayed out too late with her boyfriend. “You just pick a few stocks, and wait for them to go up.” “Buy low, sell high! Am I right?” “Twitter? I tweet all the time. I’m in. What’s an IPO?” I wish I were kidding.
The more I study the vast world of investments, the more I realize I don’t know. The more I talk with people about investments, the more I realize
how little they know
Recently, Meir Statman perfectly articulated some of the points I have long believed are crucial, yet overlooked. His article in the WSJ entitled, “Our Unconscious Investing Motives–And How They Get Us in Trouble“, explores the decision making process for different investments. He entreats the psychologist in all of us saying, “Inside all of us are wants we don’t always express or often even are aware of. When we make decisions about our money we are often looking to satisfy those hidden emotional desires instead of doing what we say we’re doing–seeking out the best return possible.” Now, nobody intentionally plays to lose, yet sometimes the financial win is not the same thing as an emotional win.
Overconfidence can be a real downer. Similar to overestimating our own driving abilities, we typically overestimate our investing abilities. “A survey of amateur traders reveals that 62% expected to beat the market during the following 12 months.” Say wha?! I would love to get back with those people in a year and see how they fared. Often, this is exacerbated by a quick win in the market. We make one good (and most likely lucky) trade, and we think we can do no wrong. Oh, the pride before the fall.
Often, these people are in and out, bobbing and weaving to make a quick 5%-10% until they get hammered. Many studies have shown that this day trader approach will do more harm than good over the long run–especially with amateur investors who don’t have the tools, expertise, and information that the professionals do (though they typically suffer from overconfidence, too.) Ask yourself, “Do I think I have a better chance then the average investor?” If your answer is yes, why? What advantage do you have that others don’t?
Fear of any financial loss is another quick recipe for disaster. Cost-averaging down has its benefits, but are you simply holding on to investments because you haven’t broke even on it? Afraid to realize losses and admit defeat? The real question should be, where can I best deploy my capital? Avoiding losses at all costs is another type of pride where we intentionally lock up money in poor investments with the hope that it’ll turn around, and our mental ledge will be in the black again. Don’t let the mental ledger on that one stock keep you from cutting losses to establish positions in better investments.
If you really want to maximize returns, temper your overconfidence and fear by doing your homework. There are a million different angles to explore when deciding on a company to invest in, and the more you study, practice, and research, the easier it becomes. There is no substitute for a rational, patient approach and disposition. Without fail, overconfidence and fear will always precede poor decisions and obfuscate your ability to think rationally leading to financial loss.