The more I dabble in investing, the more I realize that it’s something of an “opposite world” compared to the principles I use in day to day life. Things that make intuitive sense in the real world are actually failures when it comes to investing. Here are ten great examples of that phenomenon.
Be the best – settling for average is a loser’s game.
In real life, it’s always helpful to strive to be the absolute best person you can be. Putting in the sincere, concerted effort it takes to be the very best at what you do is a strong path towards success, as the lion’s share of the credit and respect go to the people who are the best. The basic principles for being the best are consistent over time: work very hard, respect and care for others, step up when leadership is called for, and handle difficult situations well. No matter what situation you’re in, those tenets will guide you towards being the best.
In investing, constantly striving for the absolute best returns will often lead you down a dangerous path. In order to achieve those kinds of “best” results, you have to take on a huge amount of risk by reducing your portfolio diversity and buying heavily into a small number of investments. Doing that puts you at a big risk – if one company runs into trouble and you’re heavily into their stock, your gains go away very quickly. The actual truth is that you’re far better off as an investor trying to get the average return at the lowest cost possible over the long haul, and that usually means being very diverse and very steady with your investments, not seeking the big win.
Self-confidence can get you far.
In real life, the appearance of success often implies the presence of success to others. Dress in an expensive suit, drive an expensive car, and act with confidence, and people will believe that you’re successful at what you do and place some confidence in you, whether founded or not.
In investing, self-confidence often leads straight to failure. Self-confidence causes you to believe you’re an expert investor and that everything you touch turns to gold. No one has the Midas touch – not even Warren Buffett or Peter Lynch. You will suffer failures as an investor, and if you’ve been too self-confident about your investment choices (resulting in behaviors like putting all your eggs in one sure thing basket), you’ll get burnt badly.
Let your heart lead, not your mind.
In real life, your internal moral code, conscience, and instinct are great guides in leading you through the labyrinth of human interactions. Gut instincts are often the result of watching many, many patterns over time, and because basic human behavior is often at least somewhat predictable, our gut instinct often leads us down the correct response path. Whenever my gut and my mind are fighting over what to do when in the real world, I usually let my gut win.
In investing, gut instincts have the opposite effect. Your gut instinct tells you to make conclusions based on recent behaviors and behaviors you’ve witnessed in the past. Thus, a short-term uptick signals a gut instinct to invest for most people. The only problem is that short term investments in most markets are extremely chaotic. They go up and down for reasons far beyond our quick perceptions, and thus just relying on our natural instincts has very little value at all. In fact, often it has a negative value, because we may interpret a natural fluctuation as being something more than the little trend it is, so we buy on the peak or sell short at the bottom and end up eating our shorts.
When in Rome, do as the Romans do.
In real life, this is an excellent principle to live by. Adopting some of the social norms around you helps you blend in much more quickly and begin establishing relationships instead of appearing as an outsider to the rest of the group. Fitting in can often be the key to defusing a social situation and making it work. Not only that, imitation is a great way to learn a new skill.
In investing, listening to CNBC all day and using their “advice” will get you nowhere. “Fitting in” with a group of people who are recommending stocks either because they’re invested themselves or based on minimal research is not a safe way to invest. Neither is reading the papers and seeing what the “hot” new investment of the minute is. If you’re reading about fantastic results and are thinking it’s time to “do as the Romans do,” it’s already too late to get the big returns – and you’ll often wind up being the one who ends up holding the bag. The same is true when there’s a selloff – the time when everyone is selling is the time for you to buy, not to sell. Do your own homework and pay no attention to the delusions and madness of the crowds.
Listen to the advice of people wiser than yourself.
In real life, it’s a great idea to heed the recommendations of experts in a field. I have a friend who is a tremendously good golfer, so when he recommends golf balls or a golf club or a training item, I’ll listen. Another friend is a tremendously good woodworker – if he recommends a router, I’ll listen. If a friend makes a suggestion about my own life when I ask for advice, I’ll listen.
In investing, listening to most recommendations will usually just lead you astray. The talking heads on television, often described as stock pickers or experts, have notoriously bad track records and often are just recommending whatever stock they have a lot of at the moment. That’s not expert advice. If you want true expert advice on how to invest your money, seek a fee-only financial planner, not someone on CNBC telling you to put all of your cash in Lugubrious Whing Whang (LWW).
A very specific focus will reap great rewards.
In real life, becoming a top person in a specific field can reap huge rewards. Take musicians, for example – one does not become an expert musician overnight. It takes focus, intensity, and dedication to master a musical instrument.
In investing, a focused intensity will keep you from properly diversifying and can leave you very open to sudden downturns. While it’s good to know what you’re investing in, if you focus in on one sector so intently that you lose sight of everything else, you’ll get burnt badly. Just ask the people who got downed by the tech stocks in 2001, or the Enron true believers in 2000-2001.
You usually get what you pay for.
In real life, this is often a solid rule of thumb for purchasing. For the most part, less expensive products are made with inferior parts and tend to wear out quicker. Being an intelligent shopper means knowing how to balance what you get with what you pay.
In investing, the cost of the type of investment advice that might help you squeeze out another percent or two is often more expensive than the financial gains you earn from the advice – not to mention the time reading it, absorbing it, and acting on it. You’re far better off figuring out a simple investing strategy on your own, one with low costs, and simply executing it yourself.
The best way to guess what will happen is to look at the past.
In real life, our previous experiences are what we use to make decisions in life. We remember early experiences and quickly translate those experiences into an educated (and often correct) choice today.
In investing, past performance is no indication of future results. A mutual fund that does great one year might be atrocious the next. A stock that’s been in the basement for years might suddenly catch fire. From 1997 to 2000, Enron’s stock quadrupled, and then 2001 happened. You can’t guess what will happen tomorrow.
Short term milestones work well to make sure you’re progressing towards your goal.
In real life, using short term milestones to move towards a big goal can be a powerful way to get you moving towards something really big. You can mark your progress slowly over time as you add more and more effort to the pot.
In investing, short term investment results are extremely volatile and are hard to use for any sort of indication of progress. Stock investments really only work over the long term – if you’re looking at the short term (and you’re not daytrading), there’s little real meaning there at all. You can’t use a month’s worth of growth or loss in your portfolio as a unit of progress towards your bigger goal. The only metric you can use in the short term is that you’re consistently investing more over time.
If everything’s crashing around you, now’s the time to stand up to the plate and take action.
In real life, the people that take action during a crisis are the ones that are seen as leaders, and they deservedly get much of the rewards for taking on that challenge.
In investing, people who spring into action during a fall in stock value are almost always making a bad move. The only time one should change an investment is when the fundamental reason for owning the investment changes. Did the company itself change? Did the company’s market situation change? Those are the questions to ask, and they have nothing to do with a short term crisis in the value of a stock, which could be caused by any number of reasons. Successful investors don’t immediately act during a crisis – they evaluate the situation carefully and don’t make rash moves.
It’s for these reasons that I prefer automatic investing. I just figure out my plan (centered around very broad-based and low cost index funds), set up the automatic investment each week or month, and then just forget about it. I rebalance once in a while, but only in that I change my contributions around so that my investment will eventually turn back into my desired allocation. And that’s it. No listening to the “experts,” no rash picks in a crisis, no believing I’m some sort of super investor. Slow and steady and calm.
It might go against my personal instincts, but it works.