One skill that separates good investors from bad investors – and great investors from those who are merely good – is the ability to understand the role that psychology plays in investing. With markets at least partially driven by fear and greed, being aware of your own flaws and controlling your emotions can help you avoid bad investment decisions. What’s more, recognising the same flaws in others can also help alert you to the investment opportunities created by market irrationality. Here are five tips to help you win the “inner game” of investing.
1. Be patient
Financial markets have a tendency to change their mind frequently in the short run. Sometimes this is justified by genuine changes in events, such as the Wall Street Crash of 1929. In other cases it is a reflection of genuine uncertainty, like the rapid fall and rise of global stockmarkets during the first few months of 2020 as people struggled to grasp the extent of the Covid-19 pandemic, and how governments and central banks would respond. But other market moves, such as the dotcom bubble at the start of 2000, were clearly influenced by changing sentiment among investors.
All this creates a lot of additional volatility. Indeed, Robert Shiller of Yale University won the Nobel Prize in 2013 for his work showing that, historically, stock prices have been much more volatile than you’d expect compared with the much lower volatility of future earnings and dividends of the underlying companies. As a result, those who have a large amount of money in shares, either in individual companies or even in the market as a whole, need to be prepared to put up with a lot of short-term volatility (which is why it is a bad idea to invest with borrowed money).
The good news is that over the medium to long term the stockmarket tends to bounce back from even the worst performances quite quickly. When you take into account the superior long-term returns of shares over most other assets, you are almost guaranteed to end up ahead over any substantial period – provided that you have the discipline not to panic and sell all your investments at the first sign of trouble. The best way to avoid this is to stick to an investment plan, such as regularly putting a fixed amount …….