Masting Investments - ch 19 Bogleheads Series at Catch a Gideon

December 1st, 2006 by digerati

This is Chapter 19 in the Bogleheads series here at Catch a Gideon. We are going through each chapter in the book and letting you know what we learned from reading it. You should buy the Bogleheads Guide to Investing. It has more examples and more depth than I’m giving here, and is overall an excellent investment book.

Mastering your Investments means Mastering Your Emotions

The paradox of money is while most people are very emotional about acquiring it, behaving emotionally about money is a recipe for losing it.

People usually buy on emotion and justify with logic. Often they aren’t aware of the real reason they bought an investment. This is the area of “behavioral economics.” While economics assumes people act in their own best interests, this fundamental assumption is questioned in behavioral economics.

Thanks to greed, investors excitedly chase performance when the market is up. Thanks to fear, they panic and sell when the market is down. Best way to lock in your losses! It’s hard to make a profit when you buy high and sell low.
Ego and Overconfidence

Apparently, 70% of Americans think they are above average. A similar percentage thinks they can beat the market. More men than women fall in this category, though everyone is susceptible. If you think you can beat stocks, you’ll find that the stock market is an expensive place to learn that you are not above average. Many will also attempt to take bold actions to correct their previous mistakes. This will almost always lead to poor market timing and bad decisions.
Loss Aversion

Loss aversion is the opposite of overconfidence. Here people are afraid to act because they may lose their investment. The worst case is when an investment is tanking and you continue to hold on because “it will go up eventually.”

Many are also so afraid to lose money that they will not enter the market at all. People will avoid joining their 401k accounts or investing in anything because they are “waiting for the right time.”

The problem is they are incurring an opportunity cost by not investing. Since no money is gone out of pocket they probably never realize it. But it’s money that won’t be compounding over time. We’ve seen the figures before, you could end up with millions less simply because you didn’t start as early as possible.

AnchoringAnchoring is the act of sticking with a broker, manager, fund, or investment because it’s what you have. Anchoring is dumb, don’t do it. Find out the facts and make the best decision for yourself. If you have a bad broker, replace him. If your investments are doing well, buy new ones.

On the other hand, don’t just jump investments or brokers because of a new marketing deal or something. If you broker is as good as the one you might replace them with, then stick with it. This will help avoid fees in the long run and keep everything easier to manage.

Conclusion

It’s important to keep emotions in check. How much and when do you need your money? If you’re saving for college, don’t check scores every day, you only need to know the annual returns (give or take) to see if you are on track. Otherwise you’re just toying with your emotions with something you have no control over.

Buy The Bogleheads Guide to Investing.