Monday, February 27, 2006

Planning for Emotional Control

We all have emotions - which is great in our personal lives, but doesn't help that much in our investment lives.

In fact, many great investors have stated that being in control of one's own emotions allows one to tread where others fear to go, and to fear to tread the well-worn path. What this means is that the best returns are generally earned when no one is considering that sector/company or timing (due to a recession, for instance), while returns earned when everyone is on the bandwagon, are typically only fair, and often poor.

Fidelity reportedly did an analysis on their then flagship "Magellan" mutual fund, and found that the average investor in the fund typically did much worse than the fund itself. Why? Timing, they found - investors piled more money in after a period of strong returns, and tended to pull more out after a period of weak returns.

So we as investors want to avoid the same fate. One way to do so is through planning. Make a plan to start the year and follow it. Write down what could cause you to want to deviate from that plan. Then when you are tempted to change your investment strategy, go and review your plan to see if you'd already predicted that could happen. For instance, bearing in mind my own plan for the year (see prior post) and my own personality, I considered that these items could possibly derail my attempts to follow my strategy:
  1. The volatility of my leveraged investments might worry me - so just ignore them and remember that volatility is the order of the day with this investment type;
  2. Ensure that I have enough money to continue to invest in my small cap stocks - I really enjoy investing in this area, and if I completely exited it, I know I'd get "itchy feet" with my other investments;
  3. Trust that the investments based on the "value screens" of others will produce worthwhile long-term results - just as they have in the past;
  4. Avoid excessive diversification, bearing in mind that superior investment results usually come from a focused portfolio.

If you read between the lines, you can see that a number of my reminders have to do with the characteristic of impatience. If I can control that within myself, this will personally make me a better investor.

The point here is that we all have our weak points, and if we recognize them, write them down, they hold less power over us. Your weak point as an investor might be the same as mine, or it might be different. As Sun Tzu is reported to have said in The Art of War:

If you know neither the enemy nor yourself, you will lose every battle, if you know yourself or the enemy you may win some battles and lose some, but if you know both yourself and the enemy, you will win every battle.

At least improve your investment "battle" chances by knowing yourself.


The Confused Capitalist

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