What we can learn from the greatest investors about emotional investing
Benjamin Graham, one of the greatest investors of all time, once said, “The investor’s chief problem – and his worst enemy – is likely to be himself.” According to legendary investors, such as Graham, Warren Buffett, and Peter Lynch among others, it’s not investments that cause people to lose money; rather, it is people who cause people to lose money.
Graham went on to say, “In the end, how your investments behave is much less important than how you behave.” Graham and many of the other legendary investors believe investing without a solid investment plan, or the patience and discipline to stick with one, can leave a person vulnerable to his emotions, which often leads to disastrous results. Emotions are what make investors do things they later regret, such as fleeing the market after a steep decline or buying at the peak of market euphoria – both of which can have a devastating impact on their long-term investment performance.
As the stock market enters a new period of volatility, investors would be well-served to follow the wisdom of these great wealth builders whose principles of patience and discipline have stood the test of time.
Warren Buffett, Chairman, Berkshire Hathaway
“Be greedy when others are fearful and be fearful when others are greedy.”
This iconic quote from the “world’s most successful investor” tells you all you need to know about inability of investors to control their emotions. Buffett knows that it is extremely difficult for humans to overcome their innate sense of fear when they see the markets plummet. Buffet, who invests strictly for the long term, sees fear and market corrections as opportunities.
Peter Lynch, Former Manager of the Fidelity Magellan Fund
“Far more money has been lost by investors trying to anticipate corrections than lost in the corrections themselves.”
No one can time the stock market with any degree of consistency. Studies have shown that investors who try often underperform the market. Over a 20-year period, from 1995 to 2015, investors earned an annualized return of 4.67 percent versus a return of 8.19 percent for the S&P 500 index, leading the study to conclude that, “When investors react, they generally make the wrong decision.”1
Charles Munger Vice-Chairman, Berkshire Hathaway
“A lot of people with high IQs are terrible investors because they’ve got terrible temperaments. You need to keep raw, irrational emotion under control.”
Most of the investment traps that can snare investors, such as chasing performance and trying to time the markets, prey on the emotions of fear and greed, neither of which have any place in a long-term investment strategy. Investors are better served by focusing on their long-term investment strategy rather than the short-term, temporary fluctuations of the market.
Putting Principles into Practice
While many in the media would have investors believe that market volatility is a time of loss, the truth is that it can be a time of opportunity for investors who are patient and disciplined, and who can stay the course for the long-term. Keeping the following points in mind from the best investors in history can help investors to remain focused and stay on track:
- Emotions invariably cause investors to do things they later regret.
- Successful, long-term investors invest contrary to the emotion of the market, buying during periods of panic and selling during periods of exuberance.
- Over time, short periods of lower returns for stocks have been followed by extended periods of higher returns.
- For the vast majority of investors, market timing leads to underperformance.
- The stock market tends to reward patient and disciplined investors who have a long-term investment perspective.
In the absence of a clear, long-term investment strategy, decisions can become reflexive responses to emotions that dominate our thought process. Studies indicate that people who have well-defined goals, a clear purpose in life, and a thoughtfully prepared plan in place, are better able to check their emotions and muster the necessary discipline to follow their plan. In doing so, they are more likely to avoid many of the behavioral mistakes that can cost them their financial security.
1Dalbar Inc. Dalbar’s 22 Annual Quantitative Analysis of Investor Behavior. 2016