Sociopaths make lousy neighbours. You don’t want your kid to grow up to be one. But no-emotion psychology – a sociopath is unfeeling and ignores emotions – is a great attitude to have towards your portfolio.
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Emotions are poison to investing. It’s normal to feel emotional pain when you lose money on stocks, or to feel exhilarated when you make money on a stock. But emotions tell us that “this time it’s different.” Emotions also make us hate losing more than we like winning – which can also lead to bad investment decisions.
That’s why experienced investors have rules in place to help reduce the effect of emotions in the investment process.
Don’t be a sociopath. But these emotion-free approaches to investing will help your portfolio.
Dollar cost averaging
Dollar cost averaging entails buying a set number or dollar value of shares at a set and scheduled time – such as on a specific day, week, month or quarter. This is commonly done with exchange-traded funds (ETF) or mutual funds.
Regular, pre-established purchases (which you may be able to automatically schedule with your broker or fund management company) help remove the emotion associated with timing share purchases. There’s no drama in trying to get the timing “just right” if you remove emotion from the decision about when to buy – something which is impossible to get “just right” anyway.
In addition to removing the emotion from the investment equation, dollar cost averaging makes financial sense. When markets are down, you end up buying more shares at a lower price. But when markets are high, you buy fewer shares because they are priced higher.
For example, let’s say you decide to automatically purchase S$250 of the Straits Times Index ETF (SGX:ES3) on the last trading day of each month. In the first month, the shares are trading at S$2.94 per share, so your S$250 would buy 85 shares. A month later, the price has dropped to S$2.85, so, you would buy 87 shares. Subsequently, the price rises to S$3.00, so you would buy 83 shares that month.
Over time, your average purchase price would usually work out to be less than if you tried to time the markets yourself. In this case, after three months, you would end up with 255 shares with an average cost of S$2.93. Thus, the term “dollar cost averaging”.
Filter out the noise
Investment news travels around the world in seconds. Anyone with a smartphone has immediate access to years of historical data, news, analysis and commentary on almost any stock or bond.
That means investors have an information problem: they have too much. Trying to sip from the fire hose of information makes it all the more difficult to ignore your emotions.
What’s an investor to do?
First, invest using a carefully thought-out plan. Before you buy anything, understand the answers to the following questions: Why am I buying? When will I sell? What are my criteria for buying new investments? You should have safeguards in place to avoid impulsive, adrenaline- or dopamine-driven decisions.
Second, turn off the noise. There is nothing in the daily deluge of data that has any impact on your long-term results. Don’t fall into the trap of market-watching. Consider establishing a personal rule that you will only check on your portfolio once a day, or better yet, once a week or once a month.
It’s no coincidence that Warren Buffett, considered by many to be the greatest investor of all time, has no way to check stock quotes in his office. Buffett only does things that contribute to his investors’ long-term profitability – and reacting to every bit of news isn’t one of them.
Keep it simple
Sometimes simple is best – especially in investing.
When you buy stock in a company, you’re buying shares – or, literally, a portion of the company. You’re a partner in the company. Would you become a partner in a business that you didn’t understand?
Some businesses are too complicated for anyone to understand. The business model of energy services and trading company Enron – one of the largest companies in the U.S. just months before it went bust in 2001 – was complicated enough to impress millions of investors. But Enron wound up being an enormous fraud. Investors who asked themselves if they understood Enron’s operations would have stayed away from the stock.
One way to tell if you’re in over your head is to see if you can explain the business of a company using a few crayons and a piece of paper. Most things worth understanding can be explained using the tools of the trade of a five-year-old.
Or, can you summarise a company’s business on an index card? If so, it passes the KISS test: Keep It Simple, Stupid.
For example, conglomerates are the opposite of KISS. Philippine company GT Capital has banking, property development, power generation, car, import, wholesaling, financing, and insurance businesses. Each one of these is complicated. Put together, they’re almost impossible to get a handle on.
Selling food. Getting metal out of the ground. Taking people from one place to another. These are businesses that a child could understand – and explain.
Investing in something you understand means that at least you have an idea of what the business is… and what success looks like. That’s why your portfolio should pass the crayon test.
Sociopathy in your life isn’t a good thing. But in your approach to investing, it is. It will help remove emotions in your investment decisions so you can limit your losses and avoid trying to time the market.
Good investing,
Kim Iskyan
Publisher, Stansberry Pacific Research
