Christopher Steward, Director of Investments and Partner at Legacy Group Capital.
One of the most important factors of successful investing might surprise you.
Professional investors talk at length about statistical models, trends and speculative investment, and the performance of the individuals or companies they’re investing in. What’s often missing from the conversation is the role of human behavior—a factor so key to building wealth that industry giants like Warren Buffett regularly emphasize the psychology behind investing.
Until the evolution of behavioral economics in the ’60s, the theory that people acted rationally to benefit their own self-interests was accepted as a part of economic theory. However, that “rational actor theory” has been disproven many times over because of emotions and biases. Buffett believes that understanding and controlling the behavioral tendencies that make us all human is part of what makes a successful investor.
People in each life stage will be impacted by different biases that shape their behavior:
• Young investors may fall victim to overconfidence, resulting in faux pas like taking on too many high-risk assets, trading excessively or ignoring market volatility.
• Middle-aged investors may be too worried about financial loss thanks to fears around the future, and this aversion may cause them to hold on to losing investments or, worse, sell winning investments too early to avoid this feared loss during times of turbulence.
• Finally, older investors on a fixed income may rely too much on familiar investments or misread the risks and benefits of an investment, reducing the chances of pivoting to fluctuations of the market.
So, how do we find the emotional discipline Buffett preaches about to earn maximal profits?
1. Find your Zen and stick with it.
In a perfect world, the economy would remain stable and profitable at all times. But in the real world, market prices do drop and investors do experience losses. Timely events, like political changes to financial policies, can create volatility that throws investors and their predictions into a tailspin.
What matters is how you respond to hard times. Liz Ann Sonders, chief investment strategist at Charles Schwab, suggests regular rebalancing of portfolios to create a baseline of discipline for investors in all life stages. By adding underperforming assets and trimming outperforming assets, you push against the two complex emotions that typically drive reactive investment behavior: fear and greed.
Once your portfolio has found its balance, expand the effort to your mindset. To reduce worry, practice habits that keep your emotions level. For example, limit your news intake around the markets, get regular exercise around your work hours and set clear investment goals for yourself.
2. Your emotions are valid. Use them.
One way to avoid letting your emotions get the best of you when it comes to investing is to rethink how the two relate to one another.
Jim Osman, a Forbes senior contributor, speaks to the power of your behavioral edge, or the understanding that biases exist and can be exploited and knowing you are just as susceptible to these biases as any other investor. It’s important to have a healthy dose of skepticism and to carefully weigh the benefits and disadvantages of each potential investment.
Do your best to separate what you hear is happening in the economy from your personal experience and preferences so that your biases don’t negatively impact your earnings—a psychological trap known as the confirmation bias. Take the time to do some self-reflection. What judgments are you making when looking at your portfolio, and what potential impact could that have on your success? Don’t let your biases override your humility.
3. Manage your emotions and go back to the basics.
No investor maintains a perfect record—not even the most seasoned investors know how to time the market right every time, and, as a result, they do experience losses. As an early-stage investor, that might be hard to put into perspective, but it’s true.
Rather than zeroing in on the latest news forecasts when a market dips, revisit the previously suggested investment goal list and make sure you have a set of predefined criteria to guide buying or selling assets. Going back to the basics—and sticking with them—can help reduce anxiety and the desire to act out of impulsivity.
Then, look at all of your assets and conduct a fundamental analysis. A fundamental analysis is the weighing of an asset based on its underlying value—value tied to financial statements, industry conditions, general economic indicators and more. If you know whether your assets are undervalued or overvalued, it’s easier to drown out short-term fluctuations to maintain a long-term strategy.
4. Don’t go it alone.
There’s no reason to go through hardship by yourself, so it’s advised to build a network of fellow investors to consult with questions or comments when the market proves unpredictable. No matter what life stage you’re in, a check-in with a friend, family member or financial advisor could be beneficial to your emotional resilience.
Some investors share their thoughts and struggles publicly on LinkedIn and have created a digital community through which they can find camaraderie and cool during both certain and uncertain times. Younger investors can share new perspectives with more senior investors and vice versa to creatively achieve success.
Strengthen your strategy to face what’s next.
Not a single person knows what the future holds—a truth that applies not just to economic forecasting, but to so many aspects of our lives. That’s why it’s important to equip yourself with as much understanding and as many healthy tools as possible to avoid becoming a case study of “strange behavior” in the field of investment psychology.
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