By Christine Song of Small Investing Insights
Over the last three months in which the market was down almost 14%, these words of Socrates are probably the best advice any financial advisor could give. On a macro level there was a lot going on: US growth got revised downward, US debt got downgraded and the Europeans dithered on a bail out for Greece. But for the majority of investors, on a micro level there was only one thing happening: the emotional brain kicked in and they ran for the exits.
When prices go down, do you happily stock up or fearfully sell? People who want to be in the stock market will go through a financial checklist which is basically asking themselves how much money do they have to invest. But what about going through an emotional check list? Knowing your emotional makeup is as important as knowing how much you have to invest.
When it comes to investing, your emotional make up is reflected in your attitude towards money. For example, I never buy anything full price and only buy when things are on sale. So how I spend my money extends into how I invest which is with a value tilt (i.e., buying a dollar for 80 cents). I would never pay full price for say, a handbag, so why would I pay up for a stock? During times of market volatility, aligning my personal spending habits with my investing ones makes it a lot easier to save me from myself!
Of course there are plenty of people who act one way in their professional lives and another in their personal ones. But under stress, when your head’s telling you one thing and your gut’s telling you another, emotion often wins. Why not set up the playing field in your favor?
Studies done on some of the greatest investors attribute their success to strength of character or discipline. Translation – they were able to keep their emotional brains in check. As Benjamin Graham (one of the father’s of value investing) said, every day Mr. Market offers to buy or sell stocks at prices which may or may not reflect a company’s intrinsic value. When you buy or sell in reaction to Mr. Market’s mood rather than on the fundamentals of the company, you are reacting to Mr. Market’s irrational mood swings. So now who’s the crazy one?
This quarter we’ve seen wild swings in the market, the tug of war between the human emotions of fear and greed. There’s still a lot of economic uncertainty out there which means there’s more market volatility to come. There’s also no shortage of recommendations to buy this! or sell that! But remember – forewarned is forearmed. Knowing your emotional make up can help save you from yourself.