Your worst financial enemy isn’t “the economy”, the taxman, or the dubious salesman. It’s yourself, or to be precise – your emotions. In particular, the emotions of fear and greed.
Human beings are emotional creatures; we cheer when our favorite team is winning, and become tearful at a sad movie. It’s what makes us what we are. But emotion has no place whatsoever in managing our money.
The financial industry bombards us with all kinds of glossy marketing, all trying to persuade us to entrust them with our hard earned dollars. Much of that message is, shall we say, misleading. They highlight the bits they want us to hear, and conveniently ignore the less favorable facts.
Our greed drive slips into gear blinding us to logical analysis. Before we know it we’ve signed a check and started dreaming of how we’ll spend our soon-to-be-acquired riches. When we suffer disappointing (after commission fee) returns at their hands we may point accusing fingers, but telling sales people not to sell is like telling dogs not to bark. No one says we have to listen.
Bull markets are similarly persuasive. Stocks have risen XX% in the past year and our greed drive wants to get in on the act. So we take the plunge, AFTER the spectacular gains, and near the top of the market. But markets are cyclical, and the direction from the top is down…
But when markets are falling (as they INEVITABLY will at times) so greed takes a back seat to his equally troublesome brother, fear. We may hold on at first, in the belief that the reversal is jut a blip, but the worse it gets the more likely fear is to win the day leading to selling at a loss.
Facts show index tracker funds produce superior returns to managed funds (after fees) so these are likely to form a significant part of your portfolio (despite glossy fund manager marketing)
Regular investment benefits from the “dollar cost averaging” phenomena. If you invest a fixed sum each month you’ll buy more at lower prices (and less at higher) thus ensuring the average price you pay is less than the average price of the investment for the period.
In his 1997 letter to shareholders of Berkshire Hathaway, chairman and legendary investor Warren Buffett wrote:
” A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.
But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.”
Rather than emotion, strategy and discipline should rule what we do with our money. We need to define our financial objectives and build a strategy for meeting them. We should then stick with that strategy unless our objectives change, or we can identify an overwhelming reason to change (not short term market fluctuations or the latest Sunday paper “hot tip”).