The biggest barrier we all face in finding financial security and success is ourselves, or more importantly, our behaviour related to our emotions. It is not the performance of your investments that will determine where you end up financially, it is your behavior as an investor. A good financial planner will keep their clients from destroying their capital. The difficult thing is we are all emotional creatures, which creates a very real risk. In fact a recent survey done by BMO on the psychology of investors reveals that 60 percent of people studied admitted to investing on impulse at least once.
Most research on modern economics is based on the idea that human beings are rational in their attempts to maximize wealth, while minimizing risk. Economists assume that people carefully assess risk and return on investment options, and choose a portfolio that suits their level of risk avoidance. However, a huge body of research demonstrates that most people will hold under diversified portfolios, trade speculatively, and not make rational decisions.
The risk here is that people often underperform the investments they own; they hold on to the losing investments too long, they are heavily influenced by the performance of past returns, and are materially influenced by herd mentality. Just look at how people react to the daily media of CNBC or BNN.
Individual investors have a limited amount of attention they can put into investing. Too little attention to important information can delay reactions, whereas too much attention, often to issues irrelevant to the investment, can lead to an overreaction.
Most people are familiar with the phrase “buy low, sell high”. In fact time and time again most people will do exactly the opposite.
There are a few investors to whom I hold dear for the consistency of their words and actions. These include David Chilton, the author of the Wealthy Barber series, the first investing book I ever read; Sir John Templeton who founded the Templeton fund empire in the 1950s and is quoted as saying the time to buy is “at the point of maximum pessimism”; and Warren Buffet, known as the oracle of Omaha who warned, “You pay a very high price in the stock market for a cheery consensus.” He means if everyone agrees with your investment choice the sale is over.
These investors have all achieved great success, in part by reminding people to do the opposite of their emotions. I recall a great quote I often use from the Baron Rothschild, an 18th century British nobleman and member of the Rothschild banking family: “The time to buy is when there’s blood in the streets.”
You don’t have far to look to identify when many investors have given into panic: the tech bubble bursting in 2000, the housing market and credit crisis in 2007-8, U.S. debt ceiling debate in 2011, and the threat of the European Union collapsing in 2011. Look through the noise of the media, and if you see that the earnings of the companies you want to buy into are strong and growing, even though the share price is getting decimated, that is the time to take your cheque book out and buy what you would have if the markets were not on sale.
Eight things your planner should be telling you to protect you from yourself:
- Make sure you have investments you understand and are comfortable with.
- Be mindful of your investment thoughts.
- Ask yourself why you bought your investments.
- Focus on the long term.
- Don’t check your holdings every day.
- Take a diet from the media.
- Never make an important buy or sell decision based solely on how you feel.
- Give yourself a cooling off period.
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