Benjamin Graham said what investors need, but few have, is a “firmness of character.” What he was referring to is the ability for investors to keep their emotions in check.
Investing success is more influenced by DQ than IQ. Our Discipline Quotient, or ability remain disciplined during emotional times, is what sets investors apart. Exercising investment discipline is a difficult endeavor, but it’s not impossible.
Buy Low, Sell High
Every investor wants to buy low and sell high, yet it is so much easier to sell low and buy high; it just feels right at the time. Very few investors have the discipline to buy low or sell high because it is contrary to how we feel.
Would you rather purchase a basket of stocks with an average P/E (price to earnings) of 13 or 34? Well, if you want to buy low, then 13 would be your answer. Yet, in March of 2009 with a market P/E of 13, no one wanted to touch stocks. Why would they? The expectation was that they were going down a lot more.
But now that the P/E is above 34, and the future looks positive, investors can’t seem to get enough of stocks.1 We often allow feelings, which are fleeting, to drive our investment decisions.
Keeping it Cognitive
One of the best ways to keep emotions at bay is to ask reflective questions. An honest assessment can often damper emotions (less giddy during good times, less fearful during bad times), and empower you to make more thoughtful decisions.
Questioning valuation, investor sentiment, debt etc… can engage the thinking brain (which forces emotions out), and give us a chance to analyze the situation. We can then calculate the actual risk, rather than rely on our emotionally skewed perception of risk.
Our perception of risk is highly fluid – it’s based on mood, media headlines and expectations. We tend to perceive less risk when times are good and overestimate risk when times are bad.
We are all influenced by emotions, especially with respect to our own money. That’s just part of being human. As your advisor, one of my primary roles is to help you remain disciplined to your plan. Together, we will think things through and ensure decisions are based on sound judgement, not on how we feel.
1. P/E calculations based on Shiller method for S&P 500 Index. The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. All indices are unmanaged and may not be invested into directly.
Information provided by The Emotional Investor. Member of The Behavioral Finance Network. Used with permission.