- Do you want to be a better investor?
- Would you like to make better decisions when markets are tanking?
- This brief 7 step guide can make it happen.
At times of stress, all investors get emotional. Decisions made under such circumstances often prove costly mistakes. This brief seven step guide offers a practical way to apply many lessons from behavioural finance to help you conquer your emotions and become a more successful investor.
STEP 1: Plan on paper
The first thing to do when investing is have a plan.
(i) Plan what you ultimately want to achieve.
(ii) Plan what you will do when the market tanks (it will at some point).
(iii) Plan what you expect from each investment.
To stand the best chance of sticking with your investment plans, and amending them intelligently when needed, write them down. The act of writing will also help you realise if you actually understand an investment, and no one should invest in something they don't have an adequate understanding of.
Keep what you write clear and brief (you don’t want to be reading a document the size of War and Peace each time you go back to review your thinking).
STEP 2: You talkin’ to me?!
Depersonalise the judgements that inform your investment decisions. This will help circumvent your ego and make it easier to change your mind.
Here are some techniques that can be used to achieve this:
(i) Frame written plans as advice to someone else whose interests you care about.
(ii) Only make decisions outside market hours; perhaps only once a week, a month, or even a year.
(iii) Where possible, express your thoughts with numbers - e.g. what is the percentage probability of getting the outcome you want?
STEP 3: Devil’s advocate worship
Seek out opinions that are different to your own, and try to make a counter-case for all of your investments. This will make it far easier to spot something going wrong with an investment in the future.
Try to find “base rates” against which you can check that your judgements are realistic. For example, if you expect to make 10 per cent a year from your investments, how does that compare with long-term returns from major stock markets?
STEP 4: Unpack your thoughts
Investors often have to make decisions based on information that is incomplete, complex and contradictory. To help see the wood from the trees, use a checklist of factors you feel are most important to making a good investment decision.
This should help prevent you getting carried away by seductive stories and allow you to focus on what really matters.
STEP 5: Eat your own feedback
In the absence of good feedback, it is always easy to avoid addressing problems. Keeping, reviewing and revising written records of investment plans creates feedback. This speeds up the process of becoming a better investor.
Review your investment rationale when you get new information. Once an investment is exited, perform a postmortem (regardless of whether the investment did well or badly) and write down the results.
STEP 6: Nudge nudge, think think
By keeping and referring back to written records you’ll soon find out where your strengths and weaknesses lie, and when you are in danger of making mistakes.
Use this self-knowledge to create a checklist of things to double-check and assess before making major investment decisions. Also, use your growing self-knowledge to create your own nudges to review investments (e.g. rebalancing).
STEP 7: Practice and persist
Practice steps 1 to 6 and persist with them. If you do, you will become a better investor and more able to make good decisions at times of emotional stress.