Wealth Building Lessons

A lot of investors get emotional when investing their money. Several studies on the subject reveal repeated patterns of irrationality, inconsistency and incompetence in the ways that people arrive at decisions when faced with uncertainty.

For example, many people place different weightage on gains and losses and on different ranges of probability. Individuals are much more distressed by potential losses than they are by equivalent gains. Typically a loss of $1 is twice as painful as the pleasure received from a $1 gain.

Individuals also respond differently to equivalent situations depending on whether it is presented in the context of losses or gains. Researchers also found that people are willing to take more risk to avoid losses than to realize gains. Faced with a sure gain, most investors are risk-averse, but faced with a sure loss, investors become risk-takers!

So, how does one become emotionless when it comes to investing? Well, following are a few ways to go about it.

1. Stay away from investing altogether
   Although this will guarantee a completely pain-free experience, you definitely won’t be able to create wealth.
2. Create rules and stick to them
   Many people will spend more time researching and analyzing alternatives on a $50 pair of shoes than they do entering an investment which might cost them $500. Make sure you are aware of all parameters which could potentially cause emotional pain before entering into an investment.

   For example, know what the maximum amount of money you want to put at risk in any given investment. This particularly applies to stock trading where “should I sell, yes……. no …….yes” thoughts can start creeping up. You also need to understand it’s OK to take a loss. No investor will make correct decisions every single time. The important thing is how you manage the loss. Remember the old saying, “Cut your losses and let your profits run”. This is true and you should make a sincere effort to adhere to it.

3. Have a strategy in place
   As we all know, investing is never a sure thing. Just like a game, you don’t know the outcome of the game until the game is over and the winner has been decided. When you play a game, you typically begin with a strategy. Well, the world of investing is not any different. You need goals and a strategy in place before putting your hard earned money on the line. Always start with a goal, and then put a strategy in place for reaching that goal.
4. Don’t be influenced by the crowd
   Herding, or being influenced by the crowd, is probably the most common mistake people make. Current sentiment is a powerful aphrodisiac that the average investor finds almost impossible to resist, which is why so many people end up buying high and selling low. The world’s most successful investors were masters of their emotion and remained un-swayed by public opinion.

   Sir John Templeton said, “To buy when others are despondently selling and to sell when others are greedily buying requires the greatest fortitude, even while offering the greatest reward.” Despite this well-known fact, there’s a conflict between our rational and emotional minds. Investors tend to feel euphoric at the top of a market and panicked and despairing at the bottom, even though logically and rationally, they understand that the greatest risk occurs at the peak of a market cycle, and the greatest opportunity at the bottom.

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