How Can We Better Understand Investing?
It is tempting to be romantic with the analytical part of investing. We studiously plot lines over charts multiple times a day or week to justify our actions, as though the more we do, the more positive results we’ll get. But investing doesn’t work this way. It doesn’t work this way, because investing nails the center of the Venn diagram of being analytical on one side and psychological on the other. If we’re all fully rational beings, we would have stopped millions of people from smoking simply by showing them a chart or two. The thing is we’re not.
We are capable of logic, yet at the same time, we’re emotional beings.
I believe we can understand that risk is required for reward, however risk cannot simply be quantified in spreadsheets. Taking risks affect us emotionally. We have to be willing to take a stance most people don’t agree with and stomach a certain level of doubt. Sure enough, investing is a game of probabilities, but there will be no instances whereby reward is guaranteed at 100%. We can be familiar with apparent risk: History, overconfidence and impatience. But we will never be familiar with obvious risk. We’ll never get a grip of the real dangerous stuff: The seemingly impossible things that we point at and say “What are the chances? Hah!”
We could have studied all cases of past pandemics, but we’ll never be able to anticipate the occurrence of COVID-19.
Once we understand that there is no 100% success in investing, we’ll come to terms that no matter how much we try to stack the odds in our favour (possibly much of them coming from technical analysis), there will be times we’ll be wrong and lose. You can do everything right and still get it wrong, because there will be some people out there who is looking at the same exact picture as you but they’re feeling a totally different mood. We’re trading based on logic, and they can be trading based on weather. We can scream and shout for all we want, but it all boils down to coming to terms that being wrong is a crucial part of the process. “What are the chances that it is still going down? Hah!” is what will ruin us.
Risk is unfair and unforgiving.
I believe it is appropriate to equate investment with exercise. We can’t possibly enjoy the benefits of exercise without some form of discomfort. We’ll be out of breath. We’ll feel sore. We’ll be exhausted after an hour or so. It is the byproduct of working out. If you’re not feeling any of these symptoms, you’re probably not working out hard enough to reap the rewards. Returns do not come for free. For everything that we want, there is a price to pay. When it comes to investing, the payment form varies from uncertainty, short-term loss to long stretches of boredom, anxiety and fear.
Feeling our emotion and knowing what to do with it is the psychological part of investing.
I don’t think we have an issue with being more skillful in plotting lines and reading charts granted we put in sufficient time and effort. I believe we have more of an issue when it comes to our behaviour in investing. The strategy can be as simple as Dollar-Cost Averaging (DCA) into S&P 500 for the next decade. The back-up plan is that we might need to look further and extend our time horizon by a couple of years. I’m sure most or all veterans would agree that the odds will be in our favour when it comes to winning. The two things that are likely to affect us are: how we feel about a seemingly boring fixed reward at the end of the decade-long wait and how we react when we’re in a recession.
It is one thing to understand risk appetite and another thing to practise risk tolerance.
The difficult part isn’t coming to terms with doing something (or not) based on logic or emotion. The difficult part is recognizing that certain decisions makes sense on paper, but it is maddeningly hard in practice. We put so much emphasis on Excels and numbers when it comes to investing, when really, we should also focus on dopamine and cortisol. Often, it is less about what we know, but how we behave. There are too much evidence in all styles of investing that, in aggregate, we put in more intelligence than is necessary. We’re constantly in search for the next best thing, the next signal sign that sometimes it is to our own detriment. Sometimes we just have to let time do its work. Sometimes it is about being humble and understanding that there will be things we can’t control. The thing we can truly be in control of is how we behave when we invest. If we’re emotionally affected by market volatility, it simply means we need to adjust our risk appetite.
