For most investors, the Investors’ Dilemma remains undefined and continues over a lifetime. The first step toward operating outside of this cycle is becoming aware of it and you have already done that (if you haven’t done that read the previous blog “Understanding the Investors’ Dilemma”). The next step is to choose an investment philosophy in which you believe. An investment philosophy is made up of three fundamental principles: your True Purpose for Money, your Market Belief, and your Investment Strategy.
The first part of choosing your investment philosophy is to develop a True Purpose for Money. This is a statement of the most important value that you want to express through the way that you use money; it is the thing that is more important than money itself. What fundamental value will drive both your investing decisions and your spending decisions going forward?
The second is to develop a Market Belief by identifying what you believe about how markets work.
The third part is to develop an Investment Strategy which is a plan to create and maintain your investment portfolio.
When you combine these three principles—your True Purpose for Money, your Market Belief, and your Investment Strategy –you have outlined your Personal Investment Philosophy.
Your true purpose for money articulates the underlying values and priorities you want to address and the commitments that you wish to fulfill through the use of our money. Most people are comfortable talking about goals or specific achievements that they want to accomplish with their money. But underlying these goals is a deeper and more meaningful value that drives the goals.
Money itself does not bring happiness and peace of mind. One needs only to follow the lives of recent lottery winners to bear this out. We all need a foundation. The cycle that explains why many investment decisions are driven by emotional and psychological biases that may be inconsistent with an investor’s long-term goals. This week I am going to explain the components that make up the cycle.
Fear of the Future: The cycle begins with a sense of uncertainty about the future, characterized by questions like: “Will there be enough money to maintain my standard of living? How much do I need to save? How do I know what is the best investment?” The media and advertisers prey upon this fear of the future in an effort to sell products.
Forecast and Predict: Because of this fear of the future, investors have a strong desire to comprehend and predict future events. If someone could tell what is going to happen with inflation, long-term interest rates, share prices, and overseas markets, there would be less to fear about the future from an investment perspective. Along these lines, investors are frequently convinced that someone has the information, power, and insight to forecast the future.
Track-Record Investing: The primary method investors employ to convince themselves that the future can be foretold is through track-record investing. This means they look for stock managers who have performed better than the market in the past with the hope that they will continue to have superior performance in the future.
Information Overload: In the past, gathering information was the best way to guide prudent investment decisions. However, the current Information Age has created access to so much information that it is easy to become overloaded. Investors feel compelled to understand all of the information: the Internet, books, newspapers, magazines, TV talk shows, advertisements, friends’ experiences, etc. Indeed, instead of reducing fears, this deluge of information often intensifies doubts about investing.
Emotion-Based Decisions: As investors, we never overcome our own humanity. Even though most investors prefer to think that they make investment decisions based upon logic, typically emotions, such as trust, loyalty, hope, greed, and fear, drive our investment decisions.
Breaking the Rules: There are three commonly accepted rules of investing: 1) Own equities 2) Diversify and 3) Rebalance. And, the golden rule of investing is: Buy when prices are low and sell when prices are high. It sounds simple. However, when investors make decisions based on emotions, they wind up breaking these seemingly simple rules, thereby sabotaging their portfolios.
Performance Losses: Performance loss means investors fail to capture the returns they expected. Unfortunately, because investors so frequently break the golden rule of investing, they do not receive the rate of return they expected. Investor performance does not equal investment performance. When this effect is compounded over a period of years, an investor’s potential for reaching financial goals is significantly decreased. Such loss creates additional frustrations and fears about the future, once again initiating the cycle.
THE RESULT: Not Enough Money and No Peace of Mind
The end result of the Investors’ Dilemma is not having enough money combined with worry, frustration, and anxiety about the inability to accomplish meaningful life goals.
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