The Investor’s Worst Enemy

“The market does not beat them. They beat themselves, because though they have brains they cannot sit tight.” ~ Jesse Livermore
What is the investor’s worst enemy? Is it fear? What about greed? Could it be poor timing or is it chasing performance?
These are all just symptoms of a disease called the self. The investor is often his or her own worst enemy.
Even the best money managers make mistakes. But the mistakes have been more prevalent lately.
For evidence of the self-defeating behaviors of investors, look no further than the dominance of passive investing over active investing in recent years. 2014 is on pace to finish as the fourth consecutive year that the S&P 500 Index has outperformed the average large-cap stock fund.
But isn’t the S&P 500 the benchmark—“the market”—that active investors are trying to beat? Adding insult to injury, the primary bond performance benchmark, the Barclays Aggregate Bond Index, is on pace to beat the average intermediate-term bond fund in 2014. That makes two major market indices that are outperforming active management.

You Can’t Control the Market but You Can Control Yourself

There are many psychological barriers that can be self-defeating in the world of investing, but the greatest may be what is called the illusion of control, which is just as it sounds: We investors think that it is necessary to do something to make things happen.
Put simply, you cannot control the market. You already know this but you may not be acting like you know it.
Daniel Goleman, author of the groundbreaking book, Emotional Intelligence: Why It Can Matter More Than IQ, says, “Self-awareness—recognizing a feeling as it happens—is the keystone of emotional intelligence.”
The operative word in Goleman’s statement, and for purposes of improving yourself as an investor, is recognizing. Notice that there is no mention of control here. Control is just another aspect of ego; there is no controlling the market. And for the unaware, there is no control of damaging emotions, such as fear and greed, or of damaging investing behaviors, such as over-trading, chasing performance, and poor timing.
Investors who have been outperforming the market in recent years may be in for a surprise when it falls into a major correction. You may have heard the old adage, “Don’t confuse brains and a bull market.” When you overestimate your knowledge and skill, you may understate the risk and exaggerate your ability to control the situation.
There is nothing wrong with optimism. It’s often a trait of successful people in any endeavor. But being too optimistic arises from overconfidence, which can lead to hubris (“I can do anything”), which can lead to mistakes, such as frequent trading.

Recognize, Observe & Manage…

You may have been taught to recognize trends and patterns, to observe markets, and to manage your portfolio. You may even do these things quite well and you have the track record to prove it.
But what about recognizing, observing and managing your behavior? Your success can easily be short-lived if you have high market awareness but low self-awareness.
With practice and with mindfulness, you can get better and faster at recognizing the most damaging, portfolio-wrecking emotions and manage them more effectively. The key to success in this regard is to observe emotions but to not act on them, at least not right away.
For example, the instant you recognize fear about market conditions, think to yourself, “That is fear.” Observe it and watch it go by like a cloud in the sky.
In summary, ego and emotions are not “wrong,” just as hurricanes and tornadoes are not wrong. However, the key to successful investing is to not allow your Self to be swept away by them, along with your money.

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