We are far more vulnerable to the seven deadly sins in the world of investing than we are in other areas of our lives. We may take a rare break from living according to ethics and norms, consciously deciding to ‘go wild’ for an evening out with the boys or the girls. The majority of us, though, go wild with certain limits in place. When in comes to investing, however, we often don’t impose a limit on our losses and treat the market like our personal casino.
Even a brief period of sinful investing can have a serious, negative impact on your long-term financial goals. The seven deadly sins cause investors to violate two holy rules: the first rule is that you must always measure your ‘real’ return—your return with inflation, taxes, and fees factored into the equation and without rationalizations—on investment. The second rule is that you must evaluate every investing decision in light of your long-term goals.
The good news is that the sins don’t have to control your investing, and I’ll offer advice that will help you manage your worst impulses.
No matter how good an investor you are, someone is always better. It is perfectly natural to be envious, and it only becomes a problem when you’re not aware of your envy or when you deny it. In the former instance, you don’t realise that a conversation with a colleague at work about her investing success is pushing you to make a particular type of investment. In the latter instance, you’re buying a particular stock because your older brother did great with it and you’ve always had an extremely competitive relationship.
Keeping envy three steps away
- Examine your motivation deeply. When your motivation is to hit the jackpot, ask yourself if you recently read about or talked about someone who hit a similar jackpot. If so, envy may be compelling you to act as you do. Solicit advice from others you trust about the investment. Do they consider it wise? Would they make a similar investment? If they are wary of it, you should be too.
- Demythologize the object of envy. We assume our colleague at work has a “green” thumb, or the investment guru whose newsletter we receive is so brilliant that he can chart trends in ways that most mortals can’t. We elevate these people to a status that they usually don’t deserve, and that makes us so envious. Demythologizing these individuals can make us less envious and less prone to investing mistakes. When we see that someone was merely lucky or his windfall was the result of years of study and hard work, envy loses its power over us.
- Identify what you really want and if investing is the best way to get it. When you’re envious of someone, you’re actually envious of what they possess. What you want is what they have—the luxury car, the security of having a pile of money or the vacation house. Consider whether investing is the best way to achieve this goal. Determine alternative ways to get what you want: A savings plan, a better-paying job and so on.
These steps don’t stop you from envying another person. Instead, they decrease the odds that the envy will get in the way of your investing.
An excessive amount of pride causes you to rationalize data that might make you look bad as an investor. It can also prevent you from taking good advice from experts. Overly proud investors are ingenious in coming up with justifications for their investment strategies. Their vanity drives them to create plausible-sounding arguments to avoid the conventional wisdom and go off on their own.
How to keep pride getting in your way
- Make a concerted effort to seek advice and knowledge, and try to take pride in your ability to discern useful from useless information. A wealth of information exists that is greater than your personal knowledge. Make it a habit to read an article or newsletter, visit a Web site, and talk to someone whose investing expertise you respect at least once a week. Use your own analytical ability to decide whether what you hear and read is worth acting upon.
- Substitute change-awareness for ego in making investment decisions. Recognize that you are not stupid because a good investment turns bad. Change-related factors are beyond your control, and smart investors make sure they are aware of changes and limit their losses, even if it means selling at a loss. They refuse to “save face” by clinging to a bad investment and hoping against hope that it turns around.
- Don’t try to outsmart the market. Approach the market with humility. Adopting a Zen-like attitude—recognizing that you are a speck in the universe of the market—puts things in perspective. The best investors really do go with the flow; they are open-minded, flexible, and contemplative. They are in tune with the market, understanding it as well as they are able and are attuned to its nuances. They are not so presumptuous as to believe that they can stay one step ahead of the market. Instead, they attempt to move in harmony with it.
Lust may seem an odd term to describe an investing relationship, yet the characteristics of lust—obsessiveness, possessiveness, desire—are also traits that just about every investor has experienced. People fall head-over-heels in love with stocks that perform well. They become infatuated with strategies that they believe are foolproof. They lose their logic and operate strictly on emotion when they become obsessed with a certain fund.
Lust prevents us from viewing our investing with logic and insight. We become so wrapped up in our investing obsession that we can’t take that crucial step backwards and observe our investing self with any degree of objectivity.
Antidote to lust
Diversify—spread your love around. We live in an unpredictable, volatile world, and unless you are truly diversified, you are likely to be burned.
Anger flares up faster than any of the other sins and it can be so powerful that before you know it, you’ve made an ill-advised investment. Angry investors always find something to be furious about, and it doesn’t have to be an individual; it can be a particular investment, the economy, or even fate. Some people are so irrationally angry that they take a dip in the market personally and vow vengeance. You get hit, you hit back. But this is a counterproductive reflex, one that causes you to make decisions in the heat of the moment that can cost you a great deal later on.
How to stop your rage from getting the best of you
Here are the signs of anger and how to deal with them:
- A red-hot desire for vengeance. You want revenge against the market in general or a broker who you feel gave you bad advice. If this sounds like you, you need to give yourself a ten count.
Specifically, wait ten days before making any investment decisions. This ten-day cooling down period is useful, since the desire to exact it is immediate and commanding. You need to step away from what’s pushing you powerfully toward a decision that may not be in your best interest. Time usually takes the edge off the desire for vengeance.
- Fury at yourself or others for making “stupid” mistakes. If you’re furious at yourself or others for doing something stupid, your impulse is to act immediately to get rid of that feeling of being stupid.
To diminish that feeling of being dumb, understand what caused you to be victimized: A failure to do your homework about an investment or source of advice; bad luck; stress and lack of time to make a thoughtful decision? Detail what you might have done to prevent the idiotic mistake.
- Anger at the poor performance of an investment. We’re so angry at how the investment performance thwarted our expectations that we want to do something about it. In most instances, watchful waiting is a better response.
Certain types of investing trigger anger in certain investors, you should do everything possible to avoid these types. Specifically, don’t:
- Seek highly volatile, microcap stock investments
- Buy a stock just to catch the momentum trade
- Invest blindly based only on a friend’s or a colleague’s recommendations or some other type of rumor or inside tip
- Trade on the day that news comes out.
- More strategies to deal with anger:
- Force yourself to take breaks from the investment world in general and your portfolio in particular
- Remind yourself that it’s business, not personal
- Keep an investing/anger journal
- Vent your anger productively.
Greed is a tricky subject when it comes to investing since the point of this activity is to make money. From a sin-based perspective, however, investors cross the line when they desire to make too much money too fast; when in their rush to make piles of money, they forget to do their homework and their expectations are wildly out of line with reality. Driven by greed, investors tend to jump on bandwagons too late and stay on too long, or they invest heavily in a stock that on the surface looks like a winner but quickly turns into a loser. They invest dreaming of riches, and these dreams distort their reasoning. A sure sign of greed is when you look at investing as the answer to your prayers, as a way out of a career that’s going nowhere or as a way to purchase something that you normally couldn’t afford.
How to keep your greed under control
- Invest slowly, knowledgably, and logically. Speed, ignorance, and reflex are the greedy investor’s enemies. Force yourself to move relatively slowly before making an investing decision. It helps because it gives you a bigger window of time in which you can think, reflect, learn, and talk about an investment. Greed preys on people who just react.
- Be careful about trying to duplicate past successes. Whatever it is that worked, don’t automatically assume it will work again. In fact, it probably won’t. Things change so quickly that the conditions that helped a given investment work in June probably won’t exist in July. Therefore, don’t let your greed lock you into an unthinking investing pattern.
- Train yourself to spot ‘’fool’s gold” investments. Greedy investors are drawn to stocks that look like pure gold. To avoid being similarly blinded, employ a certain amount of healthy skepticism when you encounter a skyrocketing stock. Force yourself to count to ten [figuratively speaking] and use that waiting time to do your homework. Remind yourself that most of the time, these incredibly, money-making stocks are not what they seem.
- Satisfy your greed through a 5 percent limit. Limit the amount of money you put in “speculative” stocks and funds to 5 per cent of your total investments. This limit will minimize the damage you do to your portfolio and perhaps satisfy the greed demons that drive you.
- Remind yourself daily that the market punishes the greedy and rewards the patient, long-term investor. Despite all the stories you may have heard or read about people becoming phenomenally wealthy through their high-investing strategies, the individuals are anomalies. At best, they are playing a zero-sum game in which they win a lot and then lose a lot.
Gluttons are addicts, only instead of being hooked on food they crave the action of trading. They operate on the assumption that more is better; that the more stocks, bonds, and funds they buy and sell, the better their results. They are never satisfied with their portfolio and always feel compelled to change it in some way. The action of investing is the only thing that satisfies them for a brief period of time.
Gluttony makes it virtually impossible to have a successful, long-term strategy. Constant buying and selling not only results in high transaction costs and taxes, but makes it more difficult to be objective, reflective, and analytical.
Put yourself on an investing diet
- Reserve 5 to 10 percent of your portfolio for aggressive trading. You enjoy and need the action of buying and selling. What you don’t need is for this need to eat away at your portfolio. Therefore, reserve a small percentage to feed this habit. If you only actively trade 100 shares instead of 1,000, you probably won’t do much damage.
- Limit your active trading to a tax-deferred account. Limiting your active trading to tax-deferred accounts will help you avoid paying big short-term capital gains taxes.
- Refuse to invest in the stocks and funds that everyone is talking about. The stock that is rated a “buy” by 20 out of 21 brokerage firms has great expectations already built into its price; the majority of people have already discovered and bought it, and the odds are against a significant number of additional people flocking to the stock and helping further inflate its price.
- Substitute buying “beaten up” stocks for high-performing ones. To satisfy your craving for action, look toward solid stocks that have taken a beating. Find a company that has a stellar reputation, a history of good performance, and other outstanding attributes, but has experienced problems that have depressed the stock price. If you can find the window when the price has fallen lower than it should, this is the moment when your impulse for action can serve you well.
- Increase benchmarking. Every investing glutton should make a practice of comparing their portfolio’s performance with various market benchmarks.
- Reduce the number of trades gradually. Don’t immediately try and go from five investments a day to one a week. You’ll find this radical transition tough to maintain. Instead, diminish your trades incrementally. Go from five trades a day to one or two a day. In a few weeks, reduce this number to three or four trades weekly. Then go to one trade a week.
Sloth is a sin of omission rather than of commission. For this reason, it is more difficult to identify, categorize, and prevent. Sloth manifests itself in many different ways, but its manifestation involves laziness, forgetfulness, procrastination, and rationalization. In other words, it takes the form of thought rather than action. Slothful investors wait for opportunities to come to them rather than seeking out opportunities. Sloth is also a sin of varying degrees. Some people are extraordinarily, consistently lazy about their investing while others are only fitfully slothful. On a sloth continuum, the following four points exist: A little lazy, erratically engaged, generally disinterested, a complete slug.
Fighting lethargy and inaction
To break this habit, establish a new routine.
- Set up an e-mail alert. If you are managing your money yourself and buying individual stocks, the e-mail alert will automatically and regularly provide you with the earnings release of the companies you own.
- Review your monthly statement with a sharp eye for changes. Be alert for any significant changes. Look at your asset allocation and determine if some event has shifted the balance such as a bond that matured.
- Determine how your mutual fund did versus the average mutual fund in the same category or how your advisor did compared to a well-publicized market index. Make this determination based on several time horizons such as the quarter, year, and a multiyear period. This way you’ll get a sense if you’re doing good, bad, or average.
In addition to incorporating these behaviors into your routine, designate a specific time and day for each of them. Determine a daily or weekly time when you will look at your e-rnail alert; identify when you’re going to set aside thirty minutes or so each month to review your statements; figure out when you can spend an hour or two evaluating and comparing your mutual fund and advisor performance to the market. Mark these dates and times on a calendar and stick to them. At first you’re going to have to make a conscious effort to incorporate them into your routine, but after a while, they will become habit.
Being conscious of the seven sins and vigilant for how they might impact your investing decisions is how you can take advantage of the market.
Note: To maintain sanctity of the source, this article follows American English.
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