The Psychology of Investing and the Markets
"If you can’t watch your investments drop by 50 percent in one day, then you don’t belong in the stock market."
- Warren Buffett
The Psychology of investing and your attitude towards stocks and the stock market will have just as large an impact on your portfolio returns as the companies you choose. It’s possible to buy a great company at the wrong time and then sell at a worse time and watch the value of your holding drop 50 percent. Most of successful investing involves your attitude towards your investments.
The market is a fickle entity that takes on many forms. Benjamin Graham, the man who put Warren Buffet on the path to riches, created the idea that the stock market was just some crazy guy with large mood swings who is always looking to buy or sell a stake in a certain company. He called this guy Mr. Market. Some days Mr. Market will be in a ridiculous mood and offer to sell to you or buy from you parts of companies at absurdly high prices. On other days the exact opposite will happen. Often times, acute investors can take advantage of Mr. Market’s mood swings and enjoy great portfolio returns. In Peter Lynch’s book One Up on Wall Street, Mr. Lynch notes that the average stock fluctuates 50 percent up and 50 percent down from a given point during one year. This is a perfect example of Mr. Market’s mood swings at work. Also, don’t believe that Mr. Market’s moods are short lived. Sometimes his depression or excitement can last for months or even years.
This brings us to another important point: Don’t invest money in the stock market unless you don’t need to see the money for at least five years. If you have some money saved for your kid’s college tuition next year at Stanford don’t invest that money in the stock market. Even if you think you’ve found the greatest company in the world, don’t invest in the stock if you need the money for something in the short or medium term. Over a period of five to ten years or more, stocks provide better returns than any other investment vehicle. However, in a period of less than five years, the return on stocks depends on Mr. Market’s mood swings.
In addition to taking advantage of Mr. Market’s mood swings it is best to do your own investment research instead of buying into mass psychology. Buying the hottest stock in the hottest industry will only leave you out in the cold (remember the internet boom of the late 1990s?). Often times it’s best to ignore the actions of the market and the moves of the masses. This will help lead you away from the world of poor investment performance and towards the path of market beating returns.