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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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Its tough in all areas of life, but its especially tough in investing, where our psychological makeup often does not work in our financial favorGet the Game Plan Mind-Set Commitment, Consistency, Courage In late 2001 I received a call from a woman named Debbie. About five years earlier she had invested about $50,000, almost entirely in tech stocks. By March 2000 some of Debbies picks were up 300 percent, and her original chunk was worth about $170,000. But as tech started to plunge that year, her portfolio did, too. In six weeks she lost over 40 percent. By the years end she had only $42,000: five years, and an $8,000 loss from her original principal. Why did this happen to Debbie? Why did this happen to thousands of people? Why did this happen to you? The tactical reason is that Debbie made a huge investment in a single sector without cushioning the tremendous risk she incurred. Its a critical misstep. But the more fundamental reason is that Debbie did not have a belief system guiding her strategies. If you are going to invest money, you need a belief system. Most of my life Ive played sports, and for the past 44 years handballs been my game. When I first started I thought it was an easy game: just hit a hard little rubber ball around a large rectangular court wearing the leather gloves. I did a lot of chasing, and a lot of losing. Determined to get better, for two years in a row I enrolled in a weeklong handball camp in Durango, Colorado, taught by Pete Tyson and John Bike. Pete, a former champion, has been handball coach at the University of Texas for 30 years. John was the current world handball champion. These guys were the masters. How did they start the camp? Not on the handball court, but off, teaching us their belief system for the game. Without those beliefs, they explained, even the fastest runner and sharpest hitter would be left flailing. Only after a grounding in the beliefs behind the game could a player expect to develop winning strategies and tactics on the court. Tyson and Bikes belief system was focused on three Cscommitment, consistency, and courage. Ive adopted them not only on the handball court, but for my financial planning clients and, in fact, in many areas of my life. The three Cs are intangibles, but theyre the key to getting tangible results. Commitment The first C is commitment. Im not talking about a congenial getacquainted handshake here. If youre going to invest you need a commitment to: Discipline. Confidence in the long-term viability of American industry. Continued learning. Yourself and your family. A Commitment to Discipline of us have a love/hate relationship with discipline. We hate to go through the rigors that discipline demands, but we are pleased with and proud of the outcome it produces. We hate dieting, but we like losing weight. We loathe going to the gym, but we like to be fit. Discipline means doing what you rationally know is good for you when you feel like doing something else. Its tough in all areas of life, but its especially tough in investing, where our psychological makeup often does not work in our financial favor. For example, we get the urge to sell when our investments are suffering, even though thats often the worst time to bail out. There may be a time to dump a stock, but you shouldnt automatically react to the normal ups and downs of the market. We buy when the market is upbeat, even though thats when we pay top dollar. In fact, individual investors reactions to the market are so counterproductive that professionals measure them to find out what not to do. When a consumer sentiment index indicates investors are bullish, thats when pros want out. When the small fry are nervous, the pros want in. There are many other examples of knee-jerk reactions determining our financial fate. For example, studies have shown that people feel more strongly about the pain of loss than the pleasure of equal gain. What does that mean in practice? As Gary Belsky and Thomas Gilovich point out in their book, Why Smart People Make Big Money Mistakesand How to Correct Them, if you feel more strongly about avoiding loss than securing gain, you end up doing things like panic selling out of wise investments because they take a temporary dip. (Selling could be a smart move in a prolonged bear market. But all too often its done in a panic, and not as part of a reasoned adjustment to your portfolio.) In a different manifestation of the same tendency, investors hold on to losing investments in hopes of avoiding having to lock in a loss.1 What does it take to avoid these impulses? Tremendous discipline. Even if what youve got in your portfolio is doing well, you might feel lousy if your neighbors is doing better. Suddenly you may find yourself trading in what youve got for what hes got, just when what hes got is hotnamely, expensive. According to Dalbar, a Boston-based financial research firm, that tendency to chase performanceand arrive late to the gamemanifested itself in spades in the 1990s. Individuals who are generally free to act on their own tend to overreact, says Dalbar president Louis Harvey. People tend more recently to pile on when the market is really high. They tend more to buy high than to sell low, which is quite a significant change over the last decade or so. Whats the upshot of this impulsive behavior? In most cases, worse returns. A Dalbar study of mutual fund flows from 1984 through 2000 showed that the average investor in stock mutual funds earned 5.3 percent a year, while the S&P 500 earned 16.3 percent a year. Some of that differential may be due to good reasons to sell, like using money to buy a home or finance a college education. But some of it is surely due to investors selling out of a desire to get out or avoid missing out. Theres an impulsive investor in all of us, and thats why discipline in its many manifestations is so important. Theres the discipline to set aside a certain amount of your income each month for investments, the discipline to stick with your plan when part of your portfolio is struggling, the discipline to stick with your plan when other investments are putting up higher numbers, the discipline to stay diversified among a number of different investments, the discipline to monitor your investments. Ill talk about the tactical reasons for many of these moves throughout the book. But behind them all is a basic belief that it takes discipline to succeed at investing. If youre not ready to be disciplined, then youre not ready to invest. A Commitment to Confidence in the Long-Term Viability of American Industry Investing in the U.S. stock market (and the bond market, for that matter) is a statement of confidence in the future of the American economy. Stock shares represent ownership in a company and therefore a stake in its profits. If companies earn moneyand more of itover time, stock prices eventually follow suit. If we look back at history we have good reason to believe that U.S. companies will continue to grow. If you have any doubt, consider the U.S. gross domestic product, a measure of the countrys output of goods and services. For most of our lifetimes, it has steadily risenfrom $91.3 billion in 1930 to $10.1 trillion in 2001, according to the U.S. Department of Commerces Bureau of Economic Analysis. In Table 1.1 you can see that it has had only seven annual declines. |
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