In my last post, I described how, in my initial foray into the stock market, I was tripped up by my emotions. An emotional response to the market is one of the worst things a value investor can do. Over the years, I have come up with a few cognitive tricks which help me combat these emotions.
Dissociation. I dissociate myself as much as possible from my stock portfolio, despite having much of my net worth invested in it. Firstly, I never depend on my portfolio for any of my living expenses. For my living expenses, I depend on my salary from my day job. Therefore, there is no immediate existential threat every time a dip occurs. Secondly, I do not have the value of my portfolio up on my screen all the time. Usually, I check my portfolio on Saturdays. Less frequent checking means I am less tempted by emotional responses. And checking my portfolio on Saturdays means that I cannot act on my emotions immediately, and I have at least one more day to cool down and think about matters rationally.
Reframing. In my mind, my portfolio is an import-export business. I import some goods (stocks), which I try to export at a profit. I adopt many of the practices of a full-fledged business, like double entry accounting, and annual compilation of balance sheets and operating statements. All businesses fluctuate according to macroeconomic and seasonal cycles, so I do not fold up shop every time business dips. I treat the stock market like my customers who are constantly bidding for my goods. I do not get mad when they lowball my wares, nor do I get fearful. I try to find out what the problem is. Perhaps I had imported a batch of bad goods (i.e. there was a mistake with my initial stock analysis). Maybe some goods were damaged during shipment (i.e. a new event has occurred that impaired stock value). I try to determine whether the problem is temporary or permanent, and then decide whether to cut my losses or hold onto the stock.
Rules-based investing. I have adopted some rules that tend to slow down my investing pace and hence blunt any emotional responses. Most of these rules operate at the portfolio level, thus giving me maximum flexibility at the level of individual stocks to choose my investments. For example, I have a maximum investment per stock rule that limits my exposure to any one stock, and thus limits the effect of any single stock dip on my portfolio. I also have “no more than 10% cash” rule that means that every time I need to liquidate a substantial position, I have to find some other investment to enter into, and vice versa. This tends to curb any impetuous entry and exit trades, and means that to make a portfolio change, I have to do 2 analyses, one of the current investment, and the other of the new impending investment. Basically, by adopting some reasonable rules and sticking to the rules religiously, I am constrained by the rules and cannot react emotionally even if I become panicked.
Do you have any tips or tricks to help you avoid bad behavior as an investment? If you found the above tips helpful, perhaps you could leave a comment and share some of your own tips and tricks.
