What you will learn in this post:
– The importance to have a dedicated and rigorous plan when investing.
– The terrible effects news and your personal environment can have on your investing decisions.
– Solid reasons to sell a stock. And “because every one is” is not one of them.
This post is about a little of investing psychology and is addressed to every investor out there that has been facing these difficult times when markets are plumbing and you think the world is over.
It’s a challenging time to experience this kind of situation, and I would like to share with you some of the things I keep in mind and do to focus on my investment strategies in those tough times rather than letting the panic and market depressing mania get over me.
Think of it more like a check list to go over to get your focus back on your investments, because odds are high that if you did your stock research promptly, not only your investment is still well on track, but you will also be able to benefit from the falling market.
Investors newbies, I wish you learn from this post as it really can give an uplift in your investments.
So let me draw you the picture.
You have found a great company to invest in.
You made the analysis and research to understand the business the considered company is in, and you have found that the company does have an economic moat.
Up until now, no flags. You go on.
(You pinch yourself to make sure it’s true and if your eyes still see correctly as this seems to good to be true, and yet, it is true)
Fortunately, your caution to follow your investment framework finally pays off as you prepared for such an opportunity: You had cash available and prepared to make a huge bet.
So you find yourself with a $2,000 share of this new business you have found. You’re impressed, everything goes according to plan.
Now is the next part, you wait until the market recognizes its true value reflected in the quoted price of the company’s stock.
While carefully monitoring your position every day, you begin to hear worrying news over television, radio, internet: “The FED decided to …” “Markets seem to engage a turnover …” “Investors are starting to go short as …”
“Well”, you say to yourself “that’s only a wind blow, let’s not be disturbed about that”.
And you decide not to pay attention to the events occurring.
Next thing you know, your uncle tells you at a family dinner that things are getting harder and harder with the family business. Apparently, banks have more and more trouble to lend money. He starts to think about stopping some activities until this troublesome situation isn’t over. You now are starting to get a little bit stressed about the situation.
You’re now thinking “Well, maybe something is going on. Should I get more attention into this?”
And 2 weeks later, you clearly see the charts.
S&P, down 8%.
Dow Industrial, down 5%.
Nasdaq, down 13%.
And you see on television after your squash game at the club with your friend Max: “This just in, many economic and financial professionals meet in their opinions. We might have been engaged in one of the biggest crisis ever …”
Now, you don’t think clearly, you’re starting to panic:
“They say it’s a crisis, markets have already plumbed, and I still have my $2,000 position on this stock in my portfolio? What, am I crazy?”
And millions of questions start to come up in your brain: “What should I do? Is is too late to sell? Or should I sell to minimize losses? Is it a worthy stock after all?”
From time to time, your good sense makes you think: “Oh come on, you’re crazy! Of course your investment is good. You have searched and waited for the perfect time to buy it. The company has an economic moat, is well financed, doesn’t have much debt, and has competent management. Don’t be fooled by the crowd. Your analysis was well done …”
You finally make up your mind by reviewing your research. And you indeed find out that nothing has changed in the company fundamentals since two months ago when you bought the stock.
No need to say, this clearly has the effect of morphine on you. You suddenly thank yourself for having taken the time to make the research before buying the stock as it makes you confident about your actions.
You feel relieved (and President Obama too).
You decide, whatever happens, to trust your judgment. As a matter of fact, you decide to buy even more shares of this company as it has gotten even cheaper than when you bought it. Another $1,000 into the stock, for a total share of $3,000.
Then, 1 year later.
The stock market seems to have recovered from this depression it had entered 1 year ago.
Markets have returned to their pre-crisis levels and your stock, as you had analyzed, had the competitiveness and catalysts to increase its value to overcome the market’s returns.
When the markets have earned 1,6% since your purchase of the stock, the stock has been roaring a whooping 35.6%, the stock meeting the company’s value and going over it.
You decide to go short and sell the stock, realizing a very nice profit.
You think for a second “Maybe the stock will keep on going up, should I keep my stake?” and you remind yourself that the plan was to wait for the market to recognize the value of the business to go short. And it was the case.
After this stressful experience, you now know that markets movements can destroy the investor’s strategy. And it’s safer for yourself as an investor to stay away from that noise, while you can trust your brain and investing framework.
After all, isn’t it great to brag about returns after having hanged on when others got away?
So, that’s the story.
I don’t know if you have been in these shoes, and maybe if you have, your portfolio hasn’t ended that well as our guy here, but I think we can all agree that these market downfalls are one tough test for the mental toughness of the investor.
Reality might be different from that story, but if you have done all the hard work about finding the good company, being able to buy it at a bargain price, sticking to your plan while the market does the job with time, you could end up losing it all because of the panic caused by the market participants’ noise.
So here are the few things I would like to share with you to help you focus on your investments and trust your brain and logic, instead of letting yourself being assaulted by market’s movements:
1) Don’t make markets’ movements a big deal
As Seth Klarman has been saying in his over-$1,000 book “Margin of Safety”, markets movements, in the short term, result in the confrontation of supply and demand as a whole.
If the market falls drastically within days, this only means that suddenly, for a mysterious reason (most of the time non-sense), there are more investors wishing to sell than investors wishing to buy, causing market prices as a whole to fall.
In the long term, economists have this great theory called “mean reversion”, stipulating that there will always be a time when the price of a stock will reflect the true value of that same stock.
Sometimes, it can take months, sometimes years (and most of the time, years), sometimes even more, but eventually, this will be the case. Once you’re in, you just have to wait for the market to work in your favor, provided your research about the company is accurate and confident.
Plus, don’t forget that stocks are actually pieces of “real” companies.
To reassure yourself, think about the reasons why a stock would have its stock price drop 10% in a few days?
Is there, according to you, a logical reason why this should be the case? For instance, are some of the company’s buildings burned? Is the CEO dead (sorry, man. I didn’t mean that)?
You see what I mean?
If you can’t find a reason why a “real” company with real, hard assets would lose value, then there is no solid justified reason why the stock price should be dropped.
So, panic isn’t justified.
Word of advice, print it and put it in front of your desk, so you can keep on looking at it:
“Stocks are not pieces of paper but pieces of a real company, and stocks prices are made up by buyers and sellers in the short term and don’t reflect the true value of the underlying business.”
2) Before buying, ask yourself on paper “Why should I buy that stock?”
Peter Lynch explains it clearly in his book “One up on Wall Street”.
You need a story.
Before actually buying the stock you have been searching, you need to be able to tell the story of the stock before you buy it, and to continue that story in the future.
You need a plan to invest.
Knowing exactly what to expect from the business value and the stock price in the future is another key point to help you not being dragged into this market price mess.
Make sure to have that story clear in your head and to write that down, because when the times are hard, you want to re-read this paper.
3) Before selling, ask yourself if the scenario you planned is realized.
And this gets me to this next point. When times are hard, if you get touched by this selling euphoria, you need to be able to remind yourself to check if the story you had told about the stock you purchased has happened.
That’s when you need to get your paper where you wrote what you thought about the stock.
If the plan isn’t realized, then wait, and stick to it.
If it is, then follow the plan and sell. But chances are if the crisis has occurred and you still have the stock in your portfolio that the plan hasn’t been realized yet.
This really serves as a point guard to your investment plan and strategy.
4) Finally, ask yourself the question “Is the reason why I want to sell fall into one of these?”
Ultimately, if your emotions have taken the lead in your mind, please make sure to answer this question.
Some of the great investors agree to say that reasons to sell a stock are:
– If your investment plan is realized
– If you happen to be wrong about the company’s valuation and research (I mean, you can go wrong, right?)
– If you can find other better opportunities to invest your money
There. Three reasons.
And I don’t see “if the markets fall”.
I personally have been able to remind of all those things, and many of you might find that I invest in a weird or classic way, but I actually write down my stocks scenarios, and go get it when I’m tempted to sell because I let my emotions taking the lead to my mind.
This has done wonders for me, and I hope that this will help you get the edge on these terrible situations when the markets plumb.
As Charlie Munger said “Number 1 job for an investor is to minimize downside.” And crises are the worst time to sell as the price is too low.
Yet, crises have happened, and they will happen again.
And I think that not only market movements in such short dramatic terms are not to be considered, but they also are a great time to find even better bargains to buy, or at least to reinforce your positions.
After all, let’s not forget that the super investors we all know like Warren Buffett have hit their better pitches in those fearful times.
Let’s not forget that.
I will end up on this: “Above anything else, trust yourself. You can think clearly!”
I wish you a happy time investing, let us become emotion masters while investing.