If you're a typical investor with typical wants and desires, at some point the stock market is going to clobber you.
At least that's how Tyler Bollhorn sees it. The author of The Mindless Investor: Make Money in the Market by Overcoming Your Common Sense and a professional trader in Kelowna, B.C., says he has spoken to thousands of investors over the years. And those conversations have led him to come to one rather nerve-racking conclusion.
"If you're a normal human being, you're predisposed to fail on the stock market," he explains. "It's pretty simple. Normal people avoid pain and pursue pleasure."
In other words, greed, fear, hope and envy rule.
Buy low. Sell high. Timing is everything. Yet with directions as simple as these, why do so many of us get them wrong? Canadians buy mining stock and watch what cost them $10 a share a year ago tumble to 30 cents – and yet they hold on hoping for a bounce. Or they sell just as a tech company is set to shoot sky high. They get emotionally attached to their investment.
"As human beings we can't get away from our emotions," says Serge Pépin, vice-president of investment strategy for BMO Global Asset Management. "That's part of our DNA so the big challenge for any investor – or any emotional being – is to get beyond them."
Envy thy neighbour
That's easier to do if your risk profile indicates you can take more chances with your money. For example, a 25-year-old who holds Sirius XM Radio Inc. stock at $3.58 a share, up from $3.27 when bought, will most likely feel calm. There's no rush to go after big returns now. The overall time horizon is long. But ask a 55-year-old how it feels to make such a meagre profit, particularly if she just lost a bundle on Iamgold when it hit a 52-week low at $4.72, and the response probably would be quite different.
Throw envy into the mix – friends seem more successful with their choices – and rationality goes out the window. The trick is to look at your own situation, rather than those of people around you, Mr. Pépin advises.
"Don't try to mimic what your neighbour is doing. He may have a totally different objective and risk profile. You want to be sure you have a sound retirement and don't end up eating cat food," he says.
It's not personal
It also pays to rethink your beliefs about trading in the first place. Robert Stammers, director of investor education at the CFA Institute in New York, has taught people how to trade and has observed how attitudes have had an impact on their decision-making. He showed how to set parameters and stops on their trades, how to let them run and what to do when they were snuffed out. Even though he explained that out of 10 trades, seven or eight would lose money and the other lucrative ones would often make up for the loss, emotions ruled when some arrows sunk.
Think of trading as investing in a business, he says.
"You take your clients out for dinner to make a sale, but if it doesn't go through, you don't go back to the office and say, 'Well, I just lost money because I had to buy them dinner,' " Mr. Stammers says. "That's the cost of doing business."
Sometimes emotions go haywire on a grand scale and cloud the judgment of individual investors. For instance, when Netflix Inc. stock lost value during the 2008-09 recession like other firms, company management borrowed money and brought the stock back up. It was a clear sign the company was set for a boom, Mr. Stammers says.
Even so, he says selling clients on it wasn't easy since they were still feeling burned by the recent massive market correction. Within two years, the stock went from just shy of $25 to climb to more than $205.
"Sometimes it's just there. It's like you can pick money up off the ground," he says. "People just don't see it because of what's going on around them."
To get perspective, Mr. Stammers suggests hiring an adviser who can walk you through an investing plan. Although he admits even advisers deal with the same emotional highs and lows as their clients, working together can balance it out.
Jason Vanclef, a financial planner in Culver City, Calif., and author of The Wealth Code 2.0: How the Rich Stay Rich in Good Times and Bad, isn't so sure about that.
"Yeah, what a bunch of crap that is," he says. "The important thing is to know how to design your own plan so when you hear the typical advice coming from advisers who are pushing their own agenda, your BS meter goes up."
Instead, think through your own beliefs about investing so you can create a portfolio that makes sense for you, he says. Once you know who you are and where you stand, that's when to call in the adviser to implement the plan and tweak it.
Mr. Vanclef says liquidity is at the heart of the problem when it comes to generating greed, hope, fear and exaltation. Put simply, money is just too easy to move around. If it was harder to buy and sell, it would force investors to slow down and think through their next move.
Mr. Vanclef says his clients' portfolios are made up of about 20 or 30 per cent of stocks, bonds, mutual funds and annuities. The rest is tied up in things such as non-traded real estate investment trusts (REIT), oil and gas, and equipment trusts that can't be moved for one, three or even five years. It's nearly impossible to act on impulse, much like a dieter who leaves a cart full of snack food at the grocery counter rather than lugging it home. No temptation to cheat.
"My way of curing the emotionality of investors is to take away their liquidity, which keeps them from shooting themselves in the foot," he says.