Strong words for a subject title? Perhaps. But nonetheless, it is true. If you do not believe me, perhaps the words from legendary Princeton University economist Burton Malkiel will lend more credibility: “Emotions get ahold of us, and we, as investors, tend to do very stupid things.” Yep, I have been there, done that, and even got the T-shirt! In fact, I have suggested for the longest time that personal finance has more to do with people’s behavior than it does finance. For example, according to my latest research, psychologist, and economist, there are at least 117 emotions (biases) that have an incredible influence on our prudent financial decision-making. Said perhaps more simply, there are 117 ways for us get it wrong! Moreover, the foundation for these various prejudices is controlled by two emotions: fear and greed.
I have always been fascinated with the field of behavioral finance, where economists try to figure out why investors repeatedly make irrational decisions and how to overcome one’s natural tendencies to do the wrong thing at the wrong time. For instance, when we succumb to fear or greed, we are essentially under the illusion that we can predict the future, which of course, we cannot. So why play that game? Regrettably, in the world of investing, we are wired to be counterproductive when fear and greed enter the arena. In other words, we are programmed to run from perceived danger, which is often a poor decision when it pertains to fear in the markets.
I have argued for years that personal self-discipline is the No. 1 delineating factor between the rich, the poor and the middle class. Successful investing is emotionally difficult. It often requires waiting for long-term results (discipline) when our portfolios get pummeled, owning an investment when others think it is a dog, staying in stocks when the market appears to be declining every day and not succumbing to the doom and gloom narrative from the hyperventilating talking heads who scream, “Armageddon!” Yes indeed, it often takes great courage not to allow fear mongering or greed to affect our sensible decision-making.
Just like you, I have biases (beliefs) that dictate how I handle my money. For example, I do not gamble (investing is not gambling!), because winning a few hundred dollars at the casino does not provide me with great pleasure. If I would lose a few hundred greenbacks, however, I am a wreck! This emotional bias is called “loss aversion,” which states that people react more strongly to the threat of a loss than the possibility of a gain. For example, if I receive a notification that I am about to be charged a $95 fee, my emotions immediately kick in while my blood pressure may rise a bit. However, if my investment portfolio increases $95 for the day, I think nothing of it. No emotions. It is chump change.
So if I am a full blown loss aversion human, why does this same bias not carry over to my investment portfolio? It is because I have another preconception known as “confirmation bias,” which is the tendency for me to search for, interpret, favor and recall information in a way that confirms my preexisting beliefs or hypotheses. For example, nobody will convince me otherwise that stock market corrections, market volatility, bear markets, recessions and especially uncertainty are the psychological price I pay for potentially high returns in the stock market. Furthermore, since I am still employed and save monthly, I am not afraid of bear markets, as I perceive them as good news, as every bear market is a potential opportunity for me to buy quality assets on sale and subsequently build my wealth faster with the succeeding bull market. Folks, this has been my belief (confirmation bias) since I started investing 35 years ago and it has served me well.
In the final analysis, I suggest that the key to making money in stocks is not to get scared out of them. This advice sounds simple to follow, but far too many folks surrender to the messenger of misery and throw in the towel when things get ugly. So, the takeaway message from this narrative is straightforward and blunt akin to a Brooklyn cabbie: We are the biggest risk to our long-term wealth creation, so toughen up cupcake and cure your bad behavior. Silence the enemy within!
