Recently I got into a discussion about the hardest to do in investing. Like it or not, emotions always come into play when it comes to investing. Some investors identify the fallacies and try to remove emotion from the decision making process and succeed, while most people tend to fall for the inherent psychological nature we humans are programmed with. Investing at some point in time becomes more about understanding human/market emotions and psychology than anything else.
Investing to grow our assets over the long run is a shared goal that we all have, but it is also important to remember that it is a zero sum game. Every time you buy a security on the market, there is a seller and vice versa. So, we need to ask ourselves the question: what does the counterparty know that we do not. Is the other person buying or selling with potentially more information/knowledge on the matter or is the move based on ignorance? This is really hard to fathom on a scale as big as the stock or bond market and macro issues that are not under anyone’s control. Chances are, there is no one single answer for all cases. As they say, predicting the future is a fools errand, but so is ignoring market psychology.
With that mind, I wanted to discuss what is the hardest thing to do in investing? I gather it is one of the three options below. Whether you agree or disagree, feel free to share your thoughts in the comments section below.
Whenever we are close to a market bottom, emotions are running deep as the fear grips most investors and we clam up and hold dear onto our hard-earned money. Buying at market depths is almost never possible to time perfectly. But at the same time, it is possible to identify relative valuation and know whether something is trading closer to the bottom than not. Fear is an important tool that has served us humans well through our evolutionary process. Our instincts have developed over the millennia to not take unnecessary risks; to avoid getting killed. When fear grips our emotions, we have a fight or flight instinct. This is a very useful emotion and should be garnered by investors.
Taking this in the context of investing, it can result in losing a big part of your nest egg (think buying/holding financial stocks in 2008/2009) or result in outsized returns (think buying non-financial companies in 2008/2009 that simply fell because there was widespread panic). As I’ve learned from my past experience, listening to others and the “experts” does not make an investment safe. I lost a lot of my money when I went after the beaten down financial sector, but also did really well in other companies — all in all, it was a valuable lesson that will serve me for the rest of my life. How does an investor know that something is just a temporary blip that will eventually bounce back or a crisis that a business cannot withstand and eventually has to go bankrupt? The ability to differentiate between the two is what sets the great investors apart from the rest.
Selling and realizing capital gains are another hard thing to do. As an asset continues to climb, our psychology tends to grow from content to greed and hubris. We expect things to continue going higher and higher with no changes ignoring all sorts of warning signs that might exist. The greed drives us into a thinking loop of “There’s no way this party is ending” or “What if I miss out on more future gains?” even after substantial gains. This is a pitfall that most investors tend to fall into, and one of the primary reasons for bubbles to arise in the economy — whether in stocks, home prices, commodities etc.
I personally feel that this is the state we are in currently. We have had a bull market running for 7-8 years and after a lot of easing from central bankers through the plateauing and shrinking of profits, investors continue to think that the stock market can never fall. Markets simply just don’t keep climbing to infinity. What goes up must come down…everything is cyclical. This lofty market too shall collapse sooner or later. Taking profits at this point in time seems prudent to me, but not so much for plenty of others in the community as regular readers may have noticed — based on the conversations on this blog.
The other hardest thing to do is sitting still. We always want to keep tweaking our portfolios trying to achieve slightly better results, trying to get more alpha. This becomes even more harder to do when we have an outsized cash position as we start thinking that the money isnt working for us. We want to swing at everything hoping to catch an easy ball and score a home run. In fact, most professional investors suffer from this as they think that they are being paid to take risks. A recent article on WSJ caught my attention reminding me of how hard it is to do nothing.
I personally think that having a decent sized cash position especially when there are elevated risks of market crash is prudent. Putting my last dollar in my investment account into a stock just so that “its working for me” is a terrible strategy. Cash provides with liquidity and immense power/leverage during market crashes as it allows for making moves that can result in outsized returns. It can supercharge the overall portfolio when stocks or other assets go on sale due to widespread panic. Remember that a lot of market crashes can be attributed to liquidity issues, and during such times: Cash is King!
There are a lot of hard things when it comes to investing. These are hard questions. Answers are even harder and more complex. There has been a lot of research published to help us with our decision making process. As is usually the case, there is no one-size-fits-all. Each investor behaves differently and uniquely depending on personal situation. What do you think is the hardest thing to do in investing? Share your thoughts below.