In the world of finance and investing, the single greatest enemy that most people will face is themselves. The reason for this is because even seasoned investors can fall prey to making emotional decisions.
The danger is that emotional decisions are very seldom intelligent decisions. This is compounded by the fact that the situations when most of us act emotionally tend to be at inflection points for our investments, the market or both. In this way, many people miss some of the greatest opportunities for investment because of emotional decision making.
There is an old adage that there are only two emotions on Wall Street … fear and greed. What this means is that most people make decisions from either the fear of losing or from greed out of a desire for gains. Unfortunately, both of these impulses frequently produce poor decisions. For example, fear tends to shake us into selling at low points in the market instead of holding on and buying more at good value prices to capture exceptional future gains. This ultimately results in our selling to the “smart money” at bargain prices for them to capture future gains. Conversely greed tends to compel us to chase after market momentum after the optimal window of opportunity has passed. This ultimately results in our buying from the “smart money” at inflated prices for them to lock-in their gain at our expense.
The way that we can move from “dumb money” to “smart money” is by making smart decisions. It should be very clear by now that emotional decisions are almost never smart decisions. The way that we can push ourselves toward consistently making intelligent decisions is by maintaining an even temperament and staying disciplined. The importance of this cannot be over-stated, since there is no amount of market knowledge that can overcome emotional decisions. Thus, learning to make rational decisions must be the first discipline that we master as investors, since it is the foundation upon which all of our future success will be built.
