When it comes to investing, people (or to be more specific, their behaviour) matter just as much as numbers and analysis. And maybe more so.
Throughout my career, I’ve seen very smart, very wealthy people make very silly financial mistakes. The source of these mistakes is not ignorance or lack of knowledge. It’s emotion. Understand the emotion – and how to control it – and we become better investors.
I recently talked to Carl Richards about this topic. Richards is the bestselling author of The Behavior Gap: Simple Ways to Stop Doing Dumb Things with Money. He’s also written a finance column in the New York Times for a number of years, explaining investment and personal finance concepts on the back of cocktail napkins. Richards is a nice guy to talk to, but when he talks about money mistakes, he doesn’t pull any punches. In his book, he outlines a very straightforward, very compelling idea: it’s our behaviour that determines a large part of our investment returns.
“We have to understand: emotion plays a huge role in investing and money generally,” he told me. “Because when you get underneath it, it’s about the most important things in our lives. Fear and security, and our homes and our kids’ future. All of that stuff is insanely emotional.”
I asked Richards whether he thought the wealthy were better able to handle the emotions of money. He doesn’t think so.
“There’s no question – in fact, I’d love it if you made this point super-clear – this is not a function of net worth, or even of experience,” he said. “You think that because you were able to build, you know, a cookie business, and to sell it for $20 million, you somehow have an ‘S’ painted on your chest when it comes to [investing].”
OK, so how can we close the behaviour gap? How can we take the emotion out of investing and stop making dumb decisions with our money?
Here are some ideas.
Ask yourself “why”?
“Make sure you can answer that question: why is your money invested the way it is?” Richards told me. “Once you have the answer to that question, only make changes when the answer to that question changes – when the why changes, not when the market changes.”
Have a bias for inaction
“Most of the time – just believe me, drill it into your head – changes are going to work against you,” Richards said. “I didn’t say all. I said most.” The secret to investment success lies in knowing the difference.
Look before you leap
“The more you delay a decision, the better a decision you’re going to make,” Richards said. “You should not be invested in any way that requires you to get out now.”
I think this is very good advice. If you’ve taken care of the “why” – that is, you’ve built your portfolio on goals – there should be little reason for frequent trading.
“Get someone between you and stupid”
These are Richards’ exact words – I love the way he puts it. Even expert investors need to find someone who can function as a sounding board. Someone who can play devil’s advocate when needed and can talk you out of stupid oversights and dumb mistakes. Obviously, both Richards and I are a little biased here: we believe the best “someone” is a professional adviser. But it doesn’t have to be. It could be a trusted accountant, a skilled lawyer, a business colleague, a mentor. The point is to have someone who can protect you from making dumb decisions, whoever that person is for you.
