The absolute worst enemy of investing and saving and thus building wealth is human emotion. Human emotion whispers in our ear every day that we should do something, take action, make decisions about our investments, etc., when in reality, most of the time we should do nothing at all.
When it comes to investing, the saying don’t just sit there, do something, should be turned around to don’t just do something, sit there. I have found the best investors and the ones with the most assets are people who understand the simple concept of periodical and unemotional investing. It really is that simple.
I would wager that if you made any serious investment decisions during these last couple of turbulent years you’ve probably made bad ones and lost money. Conversely, if you stayed pat and continued to invest into a well balanced portfolio the odds are that you have done OK. Staying pat you are more than likely sitting on a high number of shares of relatively lower-priced stocks or mutual funds. Stocks and funds that have already come a long way from the bottom and probably have a long way yet to run.
Since even the most stoic investor has faced some harrowing times lately, we shouldn’t beat ourselves up over these mistakes. Remember, in the financial world, it is not where you were, but where you are, and where you are going that is important. We need to grow from our errors and learn how to eliminate our emotions from our investing and saving.
The first thing I always suggest is that you use a financial advisor. Now I can almost hear your emotional inner voice griping that my first suggestion is a pretty self-serving one since I am an advisor and earn my living that way. But I firmly believe the best way to take your emotions off the table is to simply pass them on to someone else. Now it doesn’t have to be me; it just has to be someone who is going to put your financial well being ahead of theirs. Shop around and speak to a few advisors, I think you’ll be able to tell pretty quickly if they are on your side or just in it for the fees.
When I meet with retiring State Troopers I often see mistakes long after they’ve been made; maybe they didn’t want to put any more money into Deferred Comp because the value of their account went down a few years ago. And of course, instead of losing some percentage one year and making it another they didn’t save anything and spent it all. Or maybe it’s the retiree who moved out of the market “because I lost a lot of money” and ended up selling at the market bottom which, naturally, caused them to miss not only the spectacular 60% rally from March to December 2009, but also the opportunity to buy a lot of shares of investments at lower prices.
These mistakes are not something people should lose sleep over, they are the actions caused by your emotional side of being a human. Self-preservation, or our fight-or-flight instinct has served our species well for over 10,000 years; but while it helped us stay alive during long walks through the jungle, it is usually detrimental to successful investing.
I recently read an article in the Morningstar Advisor Magazine June edition (p.14), written by Terry Burnham, a PhD no less and portfolio manager for Acadian Asset Management. Dr. Burnham describes irrational investor behavior as being caused by what he calls the Lizard Brain; the lizard brain is “that part of the brain that wants to eat junk food, sleep in late and watch TV.” He uses interesting techniques to help him overcome his lizard brain behavior in both his investing and in his other walks of life, for example, since he is a frequent flier he is stuck eating a lot of airline food—which comes in a prepackaged box and usually has a decent looking and tasting brownie. We have all seen this little brownie, it is sometimes the highlight of the whole crappy meal; but it’s also packed full of preservatives and sugar. So before Burnham starts to eat anything he immediately covers the brownie with mayonnaise so he is not tempted to eat the darn thing.
In regards to financial matters Burnham suggests a “structurally discipline process of investing” which sounds complicated but in practice is a piece of cake. Here is an easy and simple way to have a “structurally disciplined process of investing.”
1. Figure out how much you can afford to save each month
2. Put together a portfolio of good investments across multiple asset classes
3. Calculate by percentage how much each investment should occupy in your portfolio
4. Send in your money from Step 1 automatically to buy those percentages in Step 3.
5. Rebalance to those allocations in Step 3 annually
6. Then leave it alone!
There, in six easy steps you have a pretty good un-emotional system. But, of all the steps listed above the hardest to do is the sixth one. People are always tampering with it; changing this investment; ditching this asset class for that one; moving money here; selling this at the low and buying that at the high. It’s all crazy non-productive market timing. It’s leaving for vacation with the kids loaded up in the station-wagon and at every intersection making a new decision whether to go left, right, straight or turn around. Forget the road map, forget the hotel reservation and just decide where to go based on how the weather looks, or the road surface or how hungry the kids are at that moment. The result of all this meddling is usually bedlam and does much more harm than good.
Oh, and one last thing, investing is a long-term thing and long-term is defined as at least five years; not five months, five days or five minutes, but five years! If you are going to need the money in less than five years then your advisor can suggest short-term ideas or investments but for the most part it shouldn’t be in the market.
So the next time you’re tempted to sell all your stocks or mutual funds and get into “something safe” just remember that your worst enemy is that confounded emotional voice in your head. I suggest you turn it off. And of course, never scrape the mayonnaise off your brownie.