Useful Lessons for Dealing with the Stock Market

With the market at an all-time high, even the foot-draggers still reeling from the 2008-2009 meltdown are taking a second look. No one likes to feel left out when others are making a lot of money, even on paper. So those who rely on emotion more than planning love to jump in when financial markets get frothy. Note: even in a record-high market it is not too late to start investing if you have a long-term plan and a competent financial planner to keep your feet on the ground.

Let’s see how we can learn from our past mistakes, instead of just repeating them, or looking for an outside influence to blame. Fess up; you have either done your investing this way or you know plenty of others who have. Let’s “stop the madness” now.

First, realize that investing is basically pretty simple, but we make it harder than it needs to be. “The Market” guesses what a company’s future valuation will be, based on current profit. As Morgan Housel of The Wall Street Journal puts it, “When investors are in a good mood, the pay more for the company’s shares and when they are in a bad mood, they pay less.” He says all the analysis is about predicting future emotion as much as things like politics and weather, which may also have a bearing upon a particular company’s profit.

The hard part is knowing when and where to take advantage of (retroactively noted) opportunity in the market. Most people, even in the financial analysis business, aren’t very good at it. That is why we diversify and rebalance; to minimize risk and maximize being invested when and where valuations unpredictably dip and jump.

“Focusing on short-term predictions actually decreases your chance of achieving your long term goals,” says William Morgan of Herbein Wealth Management. And all of us labor under the awkward observation that changing your mind about an investment (or anything, for that matter) is very hard. We just don’t like to admit that we are wrong, even when the evidence is staring us in the face.

Elliot Aronson, a psychologist, notes that “When an investor invests in an idea, he will tend to ignore or downplay the importance of information that might suggest he is wrong. The possibility that he might be wrong is dissonant with his belief that he is a clever, intelligent, thoughtful person.”

True fact; the ego will defend itself at almost any cost. And we are talking about the sometimes heavy financial part of that cost.

That’s why we like to buy investments about twice as much, by measurement, as we like to sell. And the reason is all about emotion and little about guidelines. Buying an investment, looking forward, with some fantasy involved, is much more pleasant than selling, looking back on a cold reality.

So we need to work with our financial planners to make sure that every buy strategy is paired with a sell strategy from the outset. Sure, conditions change, but pre-existing parameters always minimize risk. As for maximizing gain, we need those parameters to save us from our aversion to “leaving money on the table” by not having timed the peak of the market. The pursuit of which is a fool’s errand, to be sure.

The bottom line is that we will all come out better in the end if we acknowledge our tendencies and allow for them ahead of time. Let’s view awareness of some of these weaknesses as an opportunity to plan to do significantly better going forward than we may have done so far.