Humans are by their very nature emotional beings. One might even say that life would not be worth living without emotion. However, there are areas of life in which emotions cause more harm than good, and investing is certainly an example of this. Indeed, the very existence of the bull and bear cycle, of manias and depressions, is evidence that the stock market is ruled primarily by emotion, rather than cold, calculating reason. Here is what value investors Howard Marks (Trades, Portfolio) and Bruce Berkowitz (Trades, Portfolio) have said about the role of emotion in investing, and how to minimize it.
Marks: Apply conscious effort
Marks believes that natural temperament is a strong contributing factor to how emotional an investor is, an idea that he illustrates this way:
“As they say in basketball: you can’t coach height. No matter how good a basketball coach is, his players are not going to get any taller.”
With that being said, Marks does acknowledge that there are ways to become less emotional. He believes that in order to become a less emotional investor, you need to apply intentional effort to improve your process. The first thing to learn is why it’s important to be unemotional - why emotions make investors do the wrong thing.
The second thing is to actually implement this understanding. Obviously, this is much harder to do - if it were easy, everyone would do it. Personally, I have found that keeping a journal or other objective record of your investing process makes it easier to pinpoint areas of weak or emotional decision-making. Whatever you do, the important thing is to actively adjust your behavior, rather than to passively make the same mistake over and over.
Berkowitz: Resist your biology
This raises the question: Why do so many people make the same mistakes again and again? How can so many people be so wrong at the same time? For Berkowitz, it all comes down to biology:
“One of the reasons comes down to biology and how our brains are wired from prehistoric days. For example, in the Stone Age, if you saw a bunch of your buddies running really fast in the opposite direction it was usually a really good idea to run along with them, so that you didn’t become some animal’s breakfast.”
The natural impulse to follow the momentum - or the trend - is rooted in this evolutionary behavior. This is particularly true for non-professional investors, who don’t have the time to examine their decision-making, though professional money managers face their own set of unique biases and pressures too.
Berkowitz says that sometimes you need to be more like a psychologist than an accountant - how else do you explain phenomena like the Dutch tulip bulb craze of the 17th century, when investors were willing to sell their homes to buy one flower? So whenever you feel the compulsion to buy the best-performing stock, or are experiencing a fear of missing out on the latest bull rally, ask yourself: Do I really want to do this, or is it my Stone Age brain making me do it? You might be surprised to find out the answer once you do some thinking.
Read more here:
- Joel Greenblatt on His Biggest Mistake
- Warren Buffett: Complex Accounting Is a Warning Sign
- The Value Investor's Handbook: Dividend Investing
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