"To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What's needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework."
These words are spoken by Warren Buffett, probably the world’s most successful investor.
In earlier articles we have been looking at the key components to a successful investment strategy, the basis of the sound intellectual framework that Warren Buffett refers to. Starting with the importance of developing an individual financial plan (identifying the life that you want to live in the future) we then looked at the most crucial decision of all, asset allocation. We then looked at the importance of maintaining discipline by regular rebalancing as well as importance of reducing costs when investing. In this article we now turn to the importance of keeping emotions from corroding that framework.
Most investors understand the importance of remaining disciplined at times of heightened uncertainty. However, very few succeed in staying calm in turbulent markets. Indeed, many end up taking exactly the wrong course of action.
“The investors chief problem – and even his worst enemy – is likely to be himself” (Benjamin Graham). Perhaps the biggest danger is that of short-term thinking. All the available evidence tells us that there are more buyers in the stock market when share prices are rising. In a way this is an irrational view. What other product would see increased demand when prices go up! Sadly, the evidence also tells us that when stock markets are falling there are more sellers than buyers. Focusing on the long-term goal, and recognising that there will always be periods of poor investment performance (which can’t be predicted in advance, except by chance), is likely to significantly increase your chances of success.
Most investors would never consider consulting a fortune teller when making investment decisions. Yet many individuals listen to well-qualified economists expressing opinions on the TV or in the money pages of the newspapers. They can’t predict the future either but they often encourage us to change our plans for all the wrong reasons.
One of the roles of a real financial planner is to prevent investors from making mistakes. Research from Vanguard indicates that a real financial planner can add, on average, 1.5% per annum to an investors return by preventing them from making mistakes.
The last word should, I believe, come from Charles D Ellis in his excellent book Winning the Losers Game. “The hardest work in investing is not intellectual, it’s emotional. Being a rational in an emotional environment is not easy. The hardest work is not figuring out the optimal investment policy; it’s sustaining a long-term focus at market highs or market lows and staying committed to a sound investment policy.”