Investing and Emotions
Have you ever wondered why the stock market appears so wild and unpredictable at times? Is it because that’s the nature of the underlying businesses that make up the individual stocks traded on the exchange? Or does the volatility often have less to do with the performance of the individual business and their stocks, and more to do with the emotions of the individual people (investors) that buy them? If you answered the latter, you are correct. Investors and speculators are human beings with complex emotional capacities. Emotions are good in and of themselves, but when emotions control our rational behavior, they can be harmful in all areas of life. For investors, the emotions of fear and greed are always tugging at the individual to act in an impulsive, rather than thoughtful manner. Naturally, these competing emotions can lead to an overreaction by being too conservative when an excellent opportunity is right in front of you, or an under reaction by being too confident when clear warning signs are visible.
How do we suppress these emotions as investors?
The best way that we can suppress the emotions of fear and greed as investors, is to take an approach that ignores “stories” and thinks more rational and longer term through a “Value Investing” approach. How often do you hear about the next company that has some technological breakthrough that is going to be the next “big” thing? Until this company is actually showing signs of sales and earnings, this company is nothing more than a “story.” However, the strong emotion of greed grips hold of people and causes them to throw their money at a company with an unproven product and no history of actual profits. The value investing approach to investing helps an investor step back and look at hard data to determine whether an investment needs to be bought, held, or sold. This rational approach that looks at the underlying fundamentals of the company, such as its price to earnings, return on equity, etc., allows an investor to ignore the constant “noise” that is daily spewed out on various media channels. With a day and age that is driven with constant news and information, investors have to know how to sift through the plethora of irrelevant information, and ignore the emotions of fear and greed that “news” is typically intended to elicit from their readers and listeners. I’ve found it helpful to read through case studies of investments made in a particular company and held over a 25 year period to see how an investor that simply ignored the daily, weekly, monthly, and yearly noise of political strife, economic woes, new investment ideas, etc. would fare by remaining committed in their analysis of the underlying economics of the business. The case studies by Joshua Kennon have been an excellent resource for me through the years and I highly recommend his work.
Many successful investors have considered that the best quality an investor can have is not necessarily a high intelligence, but a proper temperament. This goes to show you the power that our ability to control our emotions in investing can have. Personally, I consider investing to be simple in that once you understand a few basic financial metrics and overall business fundamentals, you have the tools to find a quality business to invest in, but then I also consider investing very difficult in that you have to be willing to constantly suppress competing emotions and trust in your analysis of the underlying company enough to stick to your strategy and not buy a poor company or sell a quality company. The first step to becoming a successful investor is to recognize the power of our emotions in our decision making and to work at building confidence in our analysis of a company. Whether you believe it or not, this personal awareness puts you far ahead of others and on your way to becoming a successful investor.