“Investing is not the study of finance. It’s the study of how people behave with money.”
In an interesting blog on the psychology of money, Morgan Housel, a partner at the Collaborative Fund, a venture capital investment vehicle, describes a powerful contradiction which can only happen in the investment world.
In this world a person with no education, no investing experience, no network and limited financial resources can outperform someone with all the bells and whistles that one would expect is required to be a successful investor., The education, the money and the connections.
Investing success is all about the psychology of the investor and how they manage the flaws and biases they carry when it comes too investing. This relates to emotional intelligence, and truly knowing yourself, rather than formal education.
I have selected a few of these psychological investing factors that differentiate investing failure from success.
Discounting luck in the investing equation
Investing success is as much about luck as it is about ability and yet we don’t want to attribute success too luck. Ironically we don’t mind blaming our failures on it.
My view is that we don’t like to ascribe success to luck because that means we cannot control it happening. Luck is something we cannot influence and we don’t want to believe that our success in any way is not directly related to us.
Housel, in arguing that luck is an integral part of investing success, puts forward the thought provoking hypothesis that luck and risk are different sides of the same coin.
If you believe there is a “risk” that something could go wrong, you live with the equal view that there is a “chance” that something good could happen. Isn’t this simply a synonym for luck? And isn’t this our thinking when it comes to investing?
Thankfully while luck is a component, we aren’t going to get lucky without taking the necessary actions which leave opportunity for luck to intervene. So it isn’t all outside of our hands!
Ignoring the full cost of the investing equation
Being human we want our cake and we want it spoon fed to us. We don’t accept that for any gain, the universal balance asks for an equal loss.
This loss is not only financial.
Investing success requires sacrifice. The path to success requires patience and time in the market, as well as a great deal of fortitude in the face of the likely volatility, fear and uncertainty we will face.
We ignore or forget about this universal law of balance when embarking on our investing journey and when encountering the sacrifices many of us give up and retreat, foregoing our chances of success.
The belief that money is what determines your worth and gives you status
The stark truth is that nobody cares about your money other than wanting what you have for themselves.
Your monetary success serves merely as a source of ambition for them, or for those who fear the demands of chasing it, jealousy and envy.
Your money may buy you followers and admirers but were the money to disappear so would they.
Money is worthless to your true value. If status and affirmation is what you crave, don’t chase the money. Rather chase the value you can add to others, be of service and be a positive example of how you want your world to be and your status and validation will come from within.
Relying on what happened historically to predict the future
We want a roadmap for everything. We are constantly trying to explain things to ourselves, to predict our futures and remove the discomfort of uncertainty. History is a tantalising indicator to grasp onto as the crystal ball.
Housel argues that as the world and markets are evolving exponentially, the only prediction history is able to disclose for the future is how people will behave and what actions will result from the greed and fear that typically informs their decisions.
The key message here is don’t rely on historical data to indicate the path the future will take. Such an investing approach is bound to result in a totally unexpected and potentially undesirable conclusion.
Underestimating the power of compounding
Our brains are bad at picturing the power of compounding and exponential growth.
Bill Gates is said to have quoted, “We always overestimate the changes that will occur in the next two years and underestimate those that will occur in the next ten years”.
There are countless examples of these simple compounding ideas that fool our brains.
Consider the unbelievable example, If you were to double £1 every day for a month, on the 31st day you would have £1,073,741,824.
Because this compounding power is beyond our comprehension we tend to discount it in investing success and default to chasing short term outsize returns rather than accepting an average return over a long period and watching it grow exponentially.
Accepting social proof as the path to success
Social proof literally requires everyone to believe the same thing and to do that same thing. If we follow this proof we feel our investment decision has been validated.
This has nothing to do with good decision making or “taking the road less travelled” opportunities. It is simply following the crowd and assuming success is a given because nothing can be wrong when everyone supports this view.
Ironically success is made less likely given that the herd has created an overvalued and overdone investment, ripe for crashing.
Underestimating our emotional reaction
Despite us being naturally negative as a self defence mechanism, we have a hard time estimating the potential loss of an event and this is not because we cannot come up with a reasonable monetary number, We are likely to easily come up with this number but we are very unlikely to accurately calculate how we will react and underestimate the impact of our emotional instability on a positive outcome.
This prediction shortcoming leads us to enter risky investments with a gung ho attitude assuming our estimated room for error offers sufficient protection. When the emotional impact kicks in our initial estimation is likely to be considered inadequate leading to suboptimal investment actions like selling when the market is down and buying when it is at a high!
Chasing the thrill and excitement of investing
Paul Samuelson, the Nobel prize winning economist said; “Investing should be more like watching paint dry or grass grow. If you want excitement take $800 and go to Las Vegas”.
George Soros, an American Industrialist and hedge fund owner, known as the “Man who broke the Bank of England”, similarly stated that is you are having fun investing you are likely not making any money.
Successful investing is boring. It is about committing to a path and waiting it out. There are none of the bright shiny lights and bells that you would have for winning a jackpot in a casino, It simply richly rewards those who stick it out for the long term.
Morgan Housel expands on these areas in his blog and according to Google will be publishing a book later in 2020 exploring the psychology of money more deeply, I for one am looking forward to reading his insights further.