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Letting Emotions Drive Your Investment DecisionsMistake 2

Testing Your Emotions

It is a well known fact that 80% of professional money managers under-perform their relevant indexes. Even worse, a large percentage of investors lose money even when investing in mutual funds that out-perform their relevant indexes. Between 1980 and 1992 the most successful fund in the United States compounded annually at more than 25%, yet most investors lost money. How is this possible? The average investor held the fund for seven months. Yet with so much instant information available to us everyday, we evaluate our returns on a daily and weekly basis. Can you imagine if you did this with your home? Imagine coming home from a hard day’s work and turning on the TV or computer and evaluating the price of your home. Sounds crazy doesn’t it? Yet so many investors do this on a daily basis. One would think that access to more information should make one a better investor, right?

Successful investors will agree that these erratic emotions and actions are rooted in the psychological forces that seem to underlie most of the poor results. Warren Buffett, known as one of the world’s greatest investors, once said, “To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insight, or inside information. What is needed is a sound intellectual framework for decisions and the ability to keep emotions from corroding that framework.” Mr. Buffett is absolutely right. The fact is, we all want instant gratification; and investing is no different. We want returns without risk or time. We don’t want volatility yet we want consistency. We don’t want to do exactly the wrong thing at exactly the right time. So the next time you read your statement, or watch the financial news, ask yourself what you are really trying to accomplish here. What is your expected annual return averaged over a five-year period (not annually or, worse, weekly or daily)?

Have faith in businesses, not the stock market. If I were to ask you about how your investments are performing, could you tell me? Does it give you comfort or concern? Does thinking about it bother you? Clearly, you are not in control of the stock markets. Take control of your emotions and your plan today. Plan for less risk or volatility, if you are concerned. One of Warren Buffet’s mentors was a successful investor and writer, Benjamin Graham.

The Short Story of Benjamin Graham

Known as one of the greatest investment advisors of all time, Ben Graham wrote the timeless and classic money management book The Intelligent Investor (Harper Business Essentials). As we head into summer holidays, I can’t help but re-read this book of wisdom. Originally published in 1949, The Intelligent Investor provides emotional strategies and analytical insight that are essential to financial success. Every successful money manager on the planet uses this book as a true reference and follows the principles it contains.

Born in 1894, Graham is known as the father of value investing. Despite the dramatic stock market crash and 70% losses of 1929 through 1932, Graham survived and found the true spirit of value investing. Some of the core principles Graham developed were:

Invest for profits. An investor would not normally buy a business that did not, on proper research, appear to have a reasonable expectation of producing good profits over time. Share investors should take the same approach and buy, as Graham says, “...not on optimism, but on arithmetic.”

The future value of every investment is a function of its present price. The higher the price you pay, the lower your return will be.

No matter how cautious, the one risk you cannot eliminate is being wrong. Minimize your risk by what Graham called your margin of safety. For Benjamin Graham, the benchmark for calculating the margin of safety was the interest rate payable for prime quality bonds.

Become an investor, not a speculator. The difference is that an investor is one who invests in an operation which, through thorough analysis, promises safety of one’s principal and a return. Operations not meeting these requirements are speculative. The secret to success, he said, is inside you. By developing your discipline, you can ignore other people and the media and govern your own financial success. In the end, how your investments behave is much less important than how you behave.

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