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Emotion work; The misunderstood investment factor! February 16, 2009

Posted by shaferfinancial in Finance.
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Stock traders talk about this all the time.  Yet, most stock traders fail because they couldn’t get a handle on their emotions.  Long term investors act like it doesn’t matter; yet it does hugely matter.  There are very few folks, whom have the requisite psychological makeup naturally, for successful investing.  But that doesn’t mean you can’t acquire that emotional control to become a successful investor.  Many have. 

Unfortunately most folks don’t realize the importance of controlling one’s emotions when it comes to even buy and hold investing.  That is what is so insidious about the current retirement funding strategies forced upon workers.  No longer is someone else, a professional money manager, responsible for getting a satisfactory rate of return.  No, we all are.  And we are all no way prepared emotionally for this responsibility.

That is why Wall Street has been so successful in selling its “automatic” investing systems.  Whether it is dollar cost averaging or diversified mutual funds or index mutual funds being sold, it is all being sold upon the idea that it (the investing decisions) are made for you without having to engage your brain or your emotions.  The fact of the matter is these are just strategies to get folks who are fearful to invest in the stock market.  Overcoming fear is the main sales strategy for Wall Street.  And then there are the insurance companies who use that fear to sell their products with a “guarantee.”  All these products are sold based on the assumption that the common folk out there can’t possible learn how to invest,  managing their risk and emotions.  And successful money managers learn early on that most people will pull their money from them if there is significant losses, even if the overall return has been very high.  So even though they know how to get higher returns, they will use strategies that reduce losses so as to not freak out the investors.

Where does that leave the average investor?  Well, the first thing is that as an investor you must make it your priority to manage your emotions.  To do this you need to do the emotion work either yourself or with someone else helping you.  Data indicates it is a much easier to get someone else to help you with the needed emotion work.  That mentor or coach can calm you down, keep you focused on your goals, and keep you from making huge mistakes based on fear of loss. 

Recently, someone was giving me a little grief over my investment in Berkshire Hathaway pointing out that it is way down (over 32% last year) from its peak.  It was an interesting discussion because frankly it had never occurred to me to sell.  My plan includes long term investment in Berkshire Hathaway unless some fundamental items change its future cash flow possibilities.  Since nothing has changed (at least for the negative), no thoughts for selling.   In fact I bought a couple of extra shares over the last 6 months because the price had gone down.  So I asked this person, what was their plan?  Well this person had sold all his stocks (after the stocks had already gone down) and was in a cash position.  So I inquired what was his entrance and exit strategies for his investments?  Well, the bottom line was he had none, only reacting to his personal emotional tone.  Since he became fearful back in November he sold everything.  For this person, no planning, only emotional reactions.  Perhaps he is an extreme case?  But, the data would indicate he is more normative than I am.  Outflows over the last 6 months from mutual and hedge funds are huge.

The point is, part of doing the emotion work is to have a plan which strategizes what happens when the things look bleak and values go down, as well as when things look all rosy!  If you have a well thought out plan, then you can overcome your emotions by following the plan.  Confidence in investing overcomes fear when you have planned to the worse up front!

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