To be a successful investor, know yourself first

October 19th, 2008

Share |

To be successful investor, you have to know yourself very well. By this, we mean that you have to understand your internal motivations so that you can remain rational. This requires an X-ray vision into your own emotional state, which is not very easy to do consistently. Whether one invest in a particular investment or not, a position is taken. For example, if you choose not to invest in property, you have to decide where to put your money. If you decide to put them in ‘cash,’ you are still taking upon a position. The problem is, your investment position will inevitably influence your emotional attachment to it. There is nothing wrong with having emotional attachments as long as you remain a human being. But the important thing for investor is that you must develop the skills to detach your emotional attachment from your investment.

Today, we will elaborate more on this. Let’s say you have taken an investment position. When that happen, there will be 3 questions that you have to sort out within yourself:

  1. What should happen to the investment, looking forward? This is what should happen to the investment if the rest of the market is rational. For example, after a market crash, you have identified an undervalued stock. You buy it from the stock market. If the rest of the world is rational, the stock should reflect the intrinsic value in due time. For those who want to read more on what we mean by “undervalued,” please read our guide, Value investing for dummies. For other class of investments like property, your views on what should happen may be based on your values and vision on society.
  2. What will happen to the investment? As we all know, the market is not rational most of the time. We don’t know why, but that is how it is. When it is not rational, what will happen is not what should happen. For example, currently, we are at a bear market for stocks. Some of the good businesses, along with bad businesses are sold down indiscriminately. Some bad businesses are not sold down enough. So, assume that stocks will continue to sell off, you can see that there is a divergence between what will happen and what should happen.
  3. What you want to happen to the investment? Sometimes, there is a divergence between what you think should happen and what you want to happen. For example, let’s you you bought a stock when it is overvalued. The stock should fall in price. But you may develop such an emotional attachment to it that you want it to rise in price. In another example, let’s say you have bought an investment property. Regardless of whether you buy it at the right price or not, you want it to rise in price.

When making investment decisions, investors can make the following pitfalls:

  1. Confusing what they want to happen with what will happen. For example, those who owe debt will want inflation. But whether that will happen or not is another matter.
  2. Confusing what should happen with what will happen. For example, an investor may short overvalued technology stocks in 1998. But it turned out that these stocks continue to rise for a couple of years before crashing.
  3. Ignoring what will happen. An investor may do his/her homework and conclude that an investment should rise and want it to rise. As a result, he/she may leverage himself to that. But alas, as Keynes said, “the market can remain irrational longer than you remain solvent.” The leveraged investment turned out badly and the investor lost a lot of money.

In conclusion, before you take up any investment position, sort out your “should,” “will” and “want” first.

Tags: ,