Being a good investor is about temperament, not just market savvy. You can pick the best stock ever—but if you get nervous and sell it on a dip right before the company’s heyday, then your emotions got the best of you. This series is about the psychology of investing. I am a psychologist who invests, and not a pro investor. I cannot tell you how to invest, but I can share with you tools for dealing with your emotions and your thought process. I became an expert in taming anxiety in all its forms. I later discovered that anxiety-reduction tactics actually helped me invest better. Many of you will have encountered these ideas already, but by looking at the ‘why’ of things like psychologists do, you can become less impulsive and more Zen when navigating an erratic stock market.
Studies have shown that a little anxiety is useful, as it gives us appropriate focus and caution. But too much anxiety can interfere with rational decision-making. The anxiety about losing money has a name—loss aversion—and has been researched extensively. Losing a hundred dollars is more painful than winning a hundred dollars is rewarding. Investors’ biggest anxiety is the fear of losing the hard-earned money we put in. The next biggest anxiety is the fear of missing out (FOMO), which often translates into making a decision intended to avoid a loss that inadvertently leads us to miss out on a golden opportunity.
It’s helpful to remember that although we experience anxiety in the present, all anxiety is anticipatory or forward-looking. Anxiety is the emotion that the mind deploys to try to predict the future. As we all know, the future cannot be predicted. So the way anxiety is adaptive is that it assumes a negative future (sometimes even a catastrophic one), in order to motivate us to prepare for it. If the future indeed ends up being bad news, then we are prepared for it. If the future turns out to be rosy, then no harm, no foul. If you thought the thing growling behind you was a rottweiler, and it turned out to be a tiny dog, no biggy. Your fight or flight response is packed away for another day and you just suffered some unnecessary jitters, which won’t kill you.
The problem is that anxiety does not work as well on Wall Street, because anticipating bad things can lead you to make erroneous decisions if the future is not as bleak as you had assumed. In the stock market, every decision can be a bad one: holding a stock can be just as bad as selling it, and buying a stock can be just as bad as not buying it. In other words, in investing, all errors can cost you, whether it’s your portfolio going down or your portfolio failing to go up. It hurts either way.
It helps to understand what we’re getting wrong when we miss the mark because it’s clearly not about whether it’s a rottweiler or not. Inexperienced investors think they are picking a stock, but seasoned ones know that they are picking a company, an entire industry, geolocation, and in many ways, the global economy at large. Time is also a fourth dimension, in that we are investing at a point in time. That is why analysts spend their days looking at everything there is to know about the companies they invest in, and what’s going on in the world.
My role model was a brilliant, Ivy-league investor-scholar, who read avidly about everything. He was going beyond analyzing companies. He was trying to predict human behavior on a mass scale. That’s when I realized investors and psychologists have a lot in common. Will millions of people save or spend, stay home or travel, travel by car or by plane? Will millions more buy an Apple or a PC? Will millions drink commercial Starbucks—or will they buy or make coffee in a hundred different ways like they always had?
Any shrink will tell you, you cannot predict human behavior. People act as though past behavior is the best predictor of future behavior. Past behavior is only one variable, and can, in fact, be a negative predictor. For instance, if a company puts out a lousy product too early to market, its millions of early customers will be less likely to buy it again than people who have never tried it.
Just because we don’t have a crystal ball, doesn’t mean we’re completely helpless. There are ways to educate ourselves about what the future may hold. Here are six of them, as applied to investing.
Let’s think about prediction as an equation or algorithm. If we knew all its variables and their weights, we’d be able to calculate the result: the future. But we usually only know a few variables, at best. So let’s think about our inability to predict human behavior as a statistical error, which makes it less personal and more quantifiable.
1. Reduce the number of errors
Every time you make a decision, you introduce errors into the system. That’s a statistical fact. If you drew a decision tree, you’ll see that for every decision you make about a stock going up or down, you could be wrong. Add all those together, and you become even more likely to be wrong, kind of like tossing a coin one time and getting heads, but then tossing it so many times that you will ultimately get a lot of tails too. If I buy stock X at point A, its price can go up or down soon after my purchase. If I then sell stock X at point B, it can go up or down after I sell it. If I wait until point C, it can also go up or down. Each time I make a decision, I collect errors along the way.
If investment decisions are error-prone, then try to make fewer decisions. In real-life terms, that’s why investing for the long run is often better than making daily or frequent buying and selling decisions. In the aggregate, individual investors who buy and hold in trusted companies are more successful in the long term than those who buy and sell often.
2. Reduce error by increasing knowledge
That’s what experts do in any profession. The more they learn their stuff, the less they are guessing. So know your stuff or ask an expert. A stock ticker is just the name of a company. You wouldn’t buy a house on the basis of its street name. So why would you buy a tiny piece of a company knowing so little about it? Read about the company broadly—not just the “opinion du jour” in your feed. Every respectable brokerage firm provides its clients with a plethora of expert information, statistics, and detailed analyst reports. Get to know the company like you’re buying it. Read the news about it, especially why its stock is going up or down before you click any buttons. Understand its product, industry, customers, employees, management, market share, and how it fits with today’s economy. Where there is knowledge, there is less error. Anxiety bends to reason, so you will feel less jittery too. You will have rational reasons for your final conclusion to buy, sell, or hold. So even if you were off, you will at the very least have less cause to berate yourself.
3. After you do your research, trust your research
Ask yourself, do you believe in this company? If you don’t believe in it, why should anybody else? You are giving your money to a company to grow its business. Do you like their business and do you want it to expand? Do you think the company will utilize your hard-earned money wisely? Remember, the price fluctuations in a stock reflect what “a bunch of people” are doing with the stock that day: buying more than they are selling, or selling more than they are buying. When deciding to cross the road, would you trust your own visual research or whether “a bunch of people” are crossing the same road today? If you truly believe in the company and its product, then there is no need to focus on whether a bunch of people out there hate it today and love it tomorrow; or whether they remember it today because it posted a profit and forget it tomorrow because it’s been working hard and hasn’t done anything amazing or bad to be in the news.
4. It is not yours till it is cash
This is perhaps the trickiest thing of all, psychologically. When you look at your brokerage account, you see your stock portfolio’s value displayed in monetary terms. But really, you do not own the dollar signs unless you no longer own the stock. The dollars represent the current value of the stock should you sell it now, kind of like Zillow’s assessment of the value of the house you live in and have no intention of putting on the market. If you haven’t sold the stock, the money is not yours. You lent it to the company, remember? Simply put, it isn’t your money to lose or gain until you give up on the company and sell.
It can be a calming influence to train yourself to convert dollar signs to votes of confidence. This can help you reframe wild fluctuations of opinion in companies you believe in. If you’re not ready to give up on them, then it’s easier to handle ups and downs in sentiment than it is to “gain” money one day and “lose” it the next.
5. For the long-term investor, train your eye on the distant future
It’s easy to panic and sell too soon, then regret it when the stock climbs up Mount Everest without you. To acquire a more long-distance vision, try looking at the entire trajectory of known winners, from IPO to today. Look at Amazon, for instance. The company took forever to become profitable. While many were laughing at Amazon’s lack of profitability, Jeff Bezos was quietly building an empire under our noses. While as consumers we were still “adjusting” to buying books online, Bezos was displacing physical bookstores and publishers with cheap ebooks, used books, affordable audiobooks, and direct access to consumers. And that’s before we started buying everything else on Amazon pre- and post-Covid. The world was slowly becoming his oyster, while his stock was in the gutter. Talk about error. So if you’re in it for the long game, make sure you look far into the future, instead of focusing on the price at today’s closing or even next month. That doesn’t mean you ignore what the market is doing all together. Naturally, diligent investors keep an eye on abnormal fluctuations and events that can rattle economies.
6. If you get it wrong, go shopping
Don’t beat yourself up if you get it wrong, because nobody gets it always right. If you lost some or failed to gain some, it’s just money anyway. Unlike irreplaceable losses, the beauty of money is you can make it up with better decisions in the future. Learn from your mistakes by following stocks long after you sold them or failed to buy them.
Finally, have some cash on hand to scoop up opportunities when the market swoons. That way you’re not making a premature decision to sell something just because you want to buy something. As the great Benjamin Graham said, when the stock market is down, pretend there’s a big “For Sale” sign over the New York Stock Exchange—and go shopping for stocks at bargain prices. Remember when a mini panic grips the market, many stocks go down, including in the portfolios of pro investors like Graham and Buffett. So don’t focus on the parts of your portfolio that are sliding, but instead, see if you can counter the anxiety with a little retail therapy.