Your investment’s worst enemy : you

Posted by Tad Johnson - Feb 4th, 2008 at 5:02

Your brain is not well equipped to handle the task of investing. Don’t feel bad about it, mine is to. In fact, everyone’s brain is bad at investing. We seem to get the whole long-term/short-term thing screwed up, and we’re not terribly good with risk vs. reward.used-car-salesman1.jpg

Ask any investor who has sold just as the market starts to go up or bought at the peak of a rise. (I’ve done both).

You can easily compensate for the brain’s biological limitations by establishing an investing plan. Force your self to use the long-term planning part of your brain to write down (yes, really) your plan for the year and share it (yes, really) with a trusted friend. Your plan should include details like:

  • Monthly savings goals
  • A short list of the assets you want to buy
  • Monthly (or quarterly) investment schemes

Here’s an example for Bob, a vicenarian:

I will save $200/month, directing 50% to a US index fund, 35% to a global index fund, and 15% to a consumer staples mutual fund.

With this plan, Bob can automatically deduct the same amount from his paycheck each month and instruct his stock broker to automatically invest the same amount every month. This is called dollar cost averaging, and it smooths out all the ups & downs in the market. Such a plan saves you from making poor decisions based on fear.

Consider the scenario where the market drops 5% in a week. Bob panics and he’s tempted to sell his stocks. Fortunately, he has made the plan above and talks to Alice (his trusted friend). Together, they come to the conclusion that the market probably isn’t on the verge of collapse. Instead, Bob continues his regular investment plan and is pleasantly surprised when the market finishes the month 5% ahead of where it started. Not only did Bob avoid making a hasty sale, but he actually benefited from the brief drop by buying more shares at a lower price.

This sort of long-term planning isn’t difficult, but following through can be. Rest assured, prudent investment planning and execution will lead to consistent, safe returns over the long run.

3 Comments »

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  1. Awesome entry here… this plan is something I’ve been struggling to adhere to for a long time. Automatic deductions are key for sticking to it long-term. Keep the tips coming

    Comment by Dan M — February 4, 2008 #

  2. Thanks Dan!

    Investing now pays off big time when you’re 60. We’ll keep feeding you useful advice.

    Comment by Tad — February 4, 2008 #

  3. […] on a previous post about the psychology of investing, here’s another human psychology defect : the fallacy of […]

    Pingback by thevicenarian.com » Sunken Costs — February 14, 2008 #

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