I’ve been an investor for over twenty years. At first investing was a way to keep my financial savings working for my family. In the past decade, investing, alongside executive and life coaching, has become a significant part of my professional work. The oftentimes dysfunctional psychology of investing is fascinating to me because while I understand and recognize it at work in the general market I rarely recognize it at play in my own life and work.
Investors buy and sell equities (stock in companies) and bonds. The goal is to buy low (when the stock price is down) and sell when high—before the stock price drops again. That’s it. There are a lot of other strategies and nuances, of course, but that’s the game in a nutshell.
A wise investor is attracted to a stock for one reason or another. He evaluates the stock's fundamentals. He considers the company’s strengths and weaknesses, makes reasoned judgments about its future potential, and considers whether the nature of its business, its culture, its past performance and future potential, are all in alignment with the investor’s own values and goals.
Market psychology is a strange force. However intellectually wise an investor may be, he can be swayed by a powerful maelstrom of external stimuli. An otherwise experienced investor may find himself investing in a stock on a whimsical impulse. Without first doing due diligence on the company’s cultural health and business practices, he may buy it impulsively because friends and family recommend it or it’s currently attractive because of recent successes. Or, the investor may purchase the company’s stock because of some other driving emotional force. When emotion, impulsivity, or irrational optimism are the driving factors behind a stock purchase, the investor is at risk.
In those cases where an investor makes a purchase unsupported by the fundamentals, two compounding mistakes almost inevitably occur. When the stock fails and its price falls the investor tries to convince himself the negative events are occurring for any reason other than that the investor shouldn't have bought in the first place. Not wanting to admit failure, instead of cutting his losses by selling he doubles down. He invests more and more money in the stock telling himself at each stop on its downward trajectory that the stock has to have found a bottom and will soon begin its climb to higher prices. Trying to catch a falling knife rarely ends happily.
The other common error is just as painful to endure but takes longer to play out. The investor invests in a stock for emotional reasons. When after some time the stock fails to perform, the investor should begin reallocating resources to more favorable investments. Instead, the irrational investor seeks any sort of news or data that can be read in a light that supports the investor’s original decision to buy. He convinces himself the stock is always just on the verge of a turn-around. So, the investor puts even more resources into the stock. This cycle may play out over years until the investor regains perspective, realizes that while the capital loss may be negligible the loss in potential returns that might otherwise have been realized is significant, and the investor capitulates and sells.
I’ve made a lot of bad calls in my career as an investor. Although my number of winning stock picks is significantly higher than that of my losses, I have made some spectacularly bad investments decisions. The root of every loss was found in my either having not checked the fundamentals before investing, or allowing ego and insecurity to hold me back from cutting my losses early. I've tried to learn from those mistakes and believe I am becoming a better investor with each passing year.
Failure to be intentional and wise can lead an investor to ruin. Pouring hard-earned resources into a company without evaluating its health and ability to grow is not wise; it’s foolish. Continuing to put one’s resources into a company with little to no prospect of a return isn’t investing; it’s charity. A wise investor recognizes the difference.
People are a lot like stocks. Invest wisely.