I suspect a lot of us – due to our unique, hard wired human brains and emotions – have fixed ‘beliefs’ that get in the way of attaining excellent investing performance. That is part of the reason why there is a stock market in the first place: for every “buy” trade there is somebody on the other end selling. And vice versa. Billions of investment decisions and transactions happen each day. Even further than that: with algorithmic trading and advancements in computing technology, there are tens of millions of professional investors out there using AI and machine learning to make trading decisions.
If you want to be a long term investor and to save and invest a balanced portfolio of stocks, bonds and alternative assets over extended periods of time, then you’re going to need to overcome these psychological hang-ups in order to do well. The first step to doing that is understanding what those hang-ups are in the first place.
(1) You Sell While There’s Blood in the Streets – Watch and Wait
Here’s how the reasoning goes: you don’t want to buy now, because everybody else is scared, which makes you even more scared. So you sell losing shares, or speculative investments, or whatever you can to make cash. You sell because you think worse is to come. The market is in the red, so now’s not a time to take on excessive risk. Political events are scary: there’s a double dip recession, economists have sounded the alarm that the end is nigh, hard Brexit could happen, Donald Trump may get impeached, and so forth. You will buy back in when things are more stable.
That was the case in December 2018 when stocks sold off by nearly 20%. Tens of millions of investors had this mind-set and the market sold off by 19.5%. Yet by a country mile, the best time recently to buy stocks and stable investments was in late December 2018.
You need to train your brain to be cautious when indexes, and stocks, are uniformly going up. Not excited. Not ebullient. If you check stocks on your phone, or look them up on the internet, get in the habit of having a passive indifference when stocks rise. I tend to watch measures like the VIX (volatility index) and Put-Call Ratios for the market. When volatility is low (stocks just grind higher, day after day) and traders are betting that the market will rise (low put-call ratio), I know it is time to be cautious.
On the other hand I love opportunities like what we faced in December 2018. I will shortly be releasing a “Top-Up Meter” that articulates how to quantify when these opportunities occur (and how to benefit from them).
Many of you know the adage “buy when there is blood in the streets.” Perhaps you attribute it to Warren Buffett, or Peter Lynch, or another modern investing legend. However it was British banking magnate Baron Rothschild who made the phrase popular; he made a fortune buying into the panic that followed the Battle of Waterloo in 1815. The full adage is even more telling: “Buy when there’s blood in the streets, even if the blood is your own.“
What’s fascinating is how far back being a contrarian investor goes. People have been buying and selling stocks and shares since the Dutch East India Company founded the Amsterdam Stock Exchange in 1602.
What you really want to cultivate is a mentality where you don’t buy and sell very often at all. Instead, you wait patiently until asset prices are unfairly priced and you make outsized investments. Psychologically, you “Buy when there is blood in the streets, even if the blood is your own.” Over time you celebrate falls in asset prices (because these are great opportunities to invest). Even if they keep falling after you buy.
(2) Obsessive Compulsive Checking, Trading, Moving & Shaking
I have suffered from this since the outset of investing in stocks and shares, but after almost a decade at self-managing investments, frankly I’ve just gotten bored of assessing my position daily. That being said I know what it is like: you can install stock trading apps on your phone, there are mobile apps for all of the major investing houses, and the internet is completely chock full of opinions about, well, everything.
The reality is a bit sinister: this is how investing houses and brokers make money off of you. They encourage you to trade.
For a long while you can read about investing and actually try your hand at it. Open a trading account that your friend recommends and start buying and selling shares on a daily or weekly basis. But that isn’t really investing. It is short term gambling and speculation. The main problem is that this is stressful and unsustainable: the more you buy and sell, check and obsess, the worse your performance tends to get. It is well known that 90-95% of day traders’ end up losing money overall and not making a market-beating profit.
Many of these brokers are legally forced to advertise, for instance, that 70% of their customers lose money on their deposits. Yet they have millions of accounts!
In the 21st century we suffer from instant gratification: people want things now, and they don’t want to wait, from the queues at McDonalds with its automated order kiosks, to Amazon Prime, to Netflix and the approach we take to short-but-sweet mobile video games.
Desired Psychology: Solution to Investing OCD
You don’t buy a family house and then, when the price goes down 5%, promptly sell it. You also don’t buy a house and when it goes up by 10%, promptly sell it. Generally speaking you buy a house because it is a good investment and you settle down and live in it while you slowly chip away at paying off the mortgage.
Why should your investments be any different? The best solution to avoid obsessive checking, trading and moving in and out of positions is simple. Discipline. You need to start ignoring your investments and checking in over a longer time frame. If you check daily, start doing it every week. If weekly, start doing it monthly. Eventually get yourself into the habit of working through your investments on a monthly or quarterly basis. They will perform better, and you’ll save yourself a lot of time and heartache in the process.
(3) Not Realizing You Are in the Wrong Side of Investment Town
The third reasons is under-appreciated but equally important. Perhaps you do not realise that the space that you are playing in is on the wrong side of town. Maybe you wandered across the tracks and without realising it thought that buying land in the Ukraine or patches of forest in Canada makes 15-20% per year returns. And worse, you think that this is normal investing behaviour. So you do a boatload of research and convince yourself that sinking £20,000 on speculative property is a good idea (when it isn’t objectively speaking).
Imagine this: a guy walks into a bar and places his order at the front counter. He’s just a normal guy in a checked shirt who has walked into a busy city centre pub to grab a pint while waiting for a friend. The phone rings behind him, he turns and suddenly every single person in the bar freezes and stops moving. The only person left moving – dumbfounded, perhaps a bit scared – is him.
If you have ever seen this on TV it is called the “Freezing Time” gag (Google it, they are funny). What’s happened is that he’s been duped into thinking that every single thing was normal in the bar. Only one thing was different: everybody in the bar is in on a joke and he’s the centre of that joke. After a minute they all go back about their business as if nothing happened.
The psychology here is fascinating. Day trading, CFDs (contracts for difference), spread betting, commodity trading, short selling, FX trading, FX options and speculative property investments are all examples of the investing equivalent of the “Freezing Time” gag. Brokerages and trading platforms capitalize on the fact that you don’t know enough about long term investing to realise the difference between risky ‘short term’ trading and lower risk ‘long term’ investment strategies. The reality is that long term investing is boring. Short term risky investing looks fun, exciting and sexy.
How do you get yourself back to the right side of town? How do you commit to long term investing, when there’s so much noise out there?
Desired Psychology: Long Term Investing!
There’s a simple barometer out there, for me, and it is to check whether you are using an established and well-researched brokerage service for your investments. If you haven’t started, well, let’s get you back to that ‘right side of town.’ I would strongly recommend avoiding brokers that push complicated investing strategies that don’t involve long-term stock ownership. If you have a stocks & shares ISA, or a SIPP (Self-Invested Pension) then here is a list of some of the major investment brokerages in the UK that are a cut above the rest:
- AJ Bell Youinvest
- Hargreaves Lansdown
- Interactive Investor
- TD Direct (merging with Interactive Investor soon I believe)
- IG Group
- Alliance Trust
- Nutmeg (robo advisor)
If you are using an alternative provider, it is worth doing more research. You can always switch brokers. I would strongly caution anybody against trading CFDs (contracts for difference), spread betting, commodity trading, short selling, FX trading, FX options and any other form of speculative investing, including having heavy weightings to shares you’ve self-researched or speculative ETF’s. The above investment houses may have the facility but they don’t push it. Their primary business model is managing stocks & shares ISAs, pensions, and being an investment marketplace for active and passive investments alike (while charging you an annual management fee).
Don’t let anybody encourage you to take on much more risk than is necessary, because often these untested strategies only work for a couple of years, before they blow up and leave you stranded.
Pulling it all together: The Frugal Investors Psychology
Just to recap what you should be aiming for as a community of Frugal Investors:
- “Buy when there is blood in the
streets, even if the blood is your own.”
- Find a low-cost, balanced portfolio of stocks and bonds
- Avoid all speculative investments and avoid trading
- Check your investments on a monthly
or quarterly basis
- Realise that great investing is painfully slow and dull
- Don’t be fooled into taking on risk just to profit your broker!
- Stay on the Right Side of Investment
- Stick to traditional investing approaches and build your knowledge
- Ensure your brokerage is reliable and cost effective for your investing style
- Invest regular and often with a plan towards retirement
Frugal Investors believe in the power of compound return. The idea that you can earn a 9.5% gross return, and a 6-7% after-inflation return on a balanced portfolio of stocks and shares, should be etched into your heart. And it needs to be in order to stomach the inevitable year when stocks fall 20%, and to not get ahead of yourself thinking you’re the next Warren Buffett when they rise 33% in a year (like 2013) and your portfolio does too.
Obsessive trading and compulsive buying and selling inevitably leads to mistakes being made and poorer returns over the long haul.
There is tremendous strength to be found in your ability to do – nothing. Nothing at all. Go and play with your kids. Or in my case, sit down and write a wonderful article on long term investing. Bask in the fact that, once you remove the ‘poison dagger’ from your leg (all of those unsustainable approaches to investing your hard earned capital), you can manage your work life and your home life more effectively.