In a recent survey of Wise, Wealthy Women, the majority of the respondents said they wanted to learn more about investing. So here goes. A whole series devoted just to the topic of investing, but before we get started with the mechanics, lets get a BIG roadblock out of the way — YOU!
In case you are wondering how you can be a roadblock to your own investing success, the answer is simple but I think James Montier said it best in his book, The Little Book of Behavioral Investing: How Not to Be Your Own Worst Enemy. He says that normal human behavior often works against us when it comes to investing because it can cause us to make big mistakes. Mistakes like ignoring the fundamental principle of buying low and selling high because our internal wiring, he says, is designed so that emotion can always trumps logic. And making logical decisions is key to financial success so it is very important for us to devise strategies to overcome our natural reactions which work on a very basic level.
You may be surprised to learn that veteran investors and “experts” can fall into these traps so everyone has to be on alert at all times. Some of the major behavioral challenges and mental pitfalls Montier warns us to be on the lookout for include:
1. Making investment decisions in the heat of the moment. To overcome this mental pitfall which often leads to an emotional decision, Montier suggests the preparation of and pre-commitment to a detailed, clear plan. In other words, figure out exactly what you want to do, what your goals are, and what your parameters are before you even dive in. It’s no different than creating a plan for a road trip so that you end up exactly where you want to go.
2. Retreating when you suffer a financial loss. The market goes up and down daily and losses do occur. Yet, quite often, the correct response to a loss is to invest more because you’re essentially buying the same company that cost quite a bit more just a month ago on sale. If you did your homework in the beginning and determined that this was a good company and nothing has changed, don’t react to a downturn by selling — react to it by buying more.
3. Looking for information to prove your ideas instead of information that will disprove them. The difference is subtle, but it can make a big difference when it comes to investing. So if you considering buying stock in a company you think a company is successful, for example, you should seek out signs that indicate that it is not successful and then weigh your findings.
4. Zagging when you should be zigging. Following the crowd is so much easier than going against them, particularly when money is at stake. The key here is to step back and look at the situation and your choices objectively without the influence of other people. Make decisions based on the information, not on what everyone else is doing.
Folding your hand at the wrong time. A big part of your overall plan is when to sell. You should decide before you begin how much risk you are willing to accept, how big the losses have to be before you sell, and just as importantly, at what point you should sell. Having a detailed plan in place before you invest allows you make decisions based on a logical plan instead of your nerves or the actions of others.
Patricia Stallworth, CFP® and CDFA, is the president of PS Worth, a financial education company, the author of Minding Your Money, and the host of the Minding Your Money Minute™. Learn more by visiting MindingYourMoney.net.