Wednesday, October 1, 2014

Asymmetric Emotions Will Kill Your Portfolio

Delacroix - Ramasseuses de coquillages surprises par la marée
Fear

 
Allegorie flämisch 1604 Geiz
Greed


One of the essential ingredients of successful investing is keeping a healthy balance between greed and fear.

We are all familiar with how unbalanced these factors become at market tops and bottoms.  At the top, even negative information is met with more greed, and at the bottom, even positive information elicits fear.  Yet the reality is that life rarely unfolds in such a lopsided fashion.  In most situations, there are numerous favorable and unfavorable influences, and we must perform a delicate weighing of the situation.

For those who select individual investments of any kind, this lack of balance occurs even more frequently.  You can choose almost any stock in the Dow Jones Industrial Average and find that it has been the pariah of Wall Street at some point in the last 5 years.  And yet in most cases, we find the same company can do no wrong less than a year later.  Surely this is collective madness.

We may think we are above all this folly, but I'm not so sure.  When people talk about their investments on financial blogs, I often see a more subtle form of emotional asymmetry.  If the purchase in question immediately goes down, there is all manner of talk about random short-term fluctuations and taking the long view.  But if the purchase goes right up, there is often a claim to have "seen it coming."  That is extraordinarily dangerous thinking, where short-term losses are viewed as market noise but short-term gains are viewed as evidence of superior analysis and timing.  This is not only a mismatch of short-term and long-term thinking, but also of the greed and fear balance.

This line of reasoning distorts your response to information flow and absolves yourself from taking full responsibility for your decisions.  If this asymmetry becomes pervasive, it will ultimately kill your portfolio.