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"To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights or inside information. What's needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework." ? Warren Buffett
Warren Buffett has almost become equally well known for his investment success and wise quotations. Solving the mystery of why most people fail when it comes investing is easy; it?s looking back at you in the mirror every morning ? yes, it?s you and probably not in the way you might be thinking!
Investment success has less to do with financial knowledge (although this is critical for overall financial wellbeing) and a lot to do with our emotions.
Fact of the matter is that most people allow two emotions to drive their investment decisions. These emotions are well known to us; they are Greed and Fear. Of course, many scholars of Behavioral Finance will argue that there many other emotional states that impact how one makes financial decisions. However, we are 90 percent of the way there if we can take control of these two.
Whenever the topic of investing is broached, the inevitable subject of risk is uncovered and, although risk management is a key to successful investing, the risk mentioned is limited to one type ? market risk (aka volatility). In simple English, how much the value of your investment can go up and down (usually within the timeframe of a year). This risk is very real but represents one of only four risks you should be considering, namely: market risk, inflation risk, longevity risk and behavioural risk. In this edition of the series I would like to highlight what, to my mind, is the most dangerous of them all: behavioral risk.
Greed and fear are emotions hard etched into our subconscious and ones that cannot (and should not) be quelled or ignored. After all, our survival instincts depend on them. Go back hundreds or even thousands of years back and the common caveman depended heavily on these emotions and instinctively used them to react. If a predatory beast was speeding toward you, fear would take hold and you would have to respond without the luxury of weighing up the pros and cons of running for your life! In essence, we are hard wired to move toward things that are perceived to be beneficial for us (prospect of food for the caveman) and move away from anything that could mean potential disaster for us. Bring this into the sophisticated world of investing and one is sure of some startling results.
Bull markets attract hoards of investors all trying to get a piece of the action only to find the raging bull being replaced by a grizzly bear market arriving just in time to wipe out a large chunk of your money before any returns were even enjoyed. After witnessing your hard earned money being raided by this vicious bear, it is not long before you decide to get out before you lose everything.