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Investing is difficult unless you master your mindset.
The math component of the investing process is not what makes investing difficult. The difficulty lies in our ability/inability to control our emotions. Investing requires us to understand how we react in various situations.
After having invested for almost 4 decades, I distill my approach to investing into the following.
Market Behavior
Over the very long-term, the broad market is likely to continue its ascent. In the very short-term, however, we have no control over market behavior.
If you monitor share price behavior over a short time frame, you have likely come to the realization that the broad markets behave like a pendulum. Greed and fear influence share price behavior.
The underlying fundamentals of a company may not change yet it is not uncommon for the share price to plunge or surge.
Looking at the 52 week price range of some of the holdings in the FFJ Portfolio, it is not uncommon to see a significant variance.
- Visa (V), my largest holding, currently reflects a low/high range of $252.70 - $357.15 - a $104.45 variance.
- Mastercard (MA), my second largest holding, currently reflects a low/high range of $428.86 - $576.94 – a $148.08 variance.
Nothing fundamentally changes in the short-term to justify such variances.
When share prices are rising, it can feel like they will never pullback. When share prices crash, it can feel like they will never recover. History, however, shows that share prices can overshoot in either direction. This explains why companies can sometimes go from being undervalued to overvalued, and vice versa, in what is a relatively short time frame.
By understanding that short-term share price behavior can be irrational, we can avoid making emotional decisions when the pendulum ‘overshoots’. This way we can mentally prepare for both extremes.
Falling Markets Reveal Who We Are
It is very easy to call ourselves long-term investors when our portfolio is growing. Our true self, however, presents itself when the value of our portfolio drops 30+%. Do significant pullbacks expose the gap between how we perceive ourselves as investors and how we really are?
Far too often, investors focus on the return component of risk/reward. When ‘stuff hits the fan’ is when we really find out if we truly believe in our investment holdings or if we are just enjoying the ride up.
Panic Is Infectious
Our brains are wired for survival, and therefore, panic can set in if we witness other shareholders aggressively exiting holdings to which we have exposure.
Panic is equally, if not more, infectious than infectious diseases. Are you the type of investor who is highly susceptible to panicking and making irrational investment decisions?
Panic spreads very quickly and even rational people can get caught up in the ‘head for the exits’ herd mentality.
Recognizing that panic can lead to horrendous investment decisions can help us stick to our financial plan.
A critical question to ask is whether we are sticking to our long-term plan or whether our emotions are leading us to make irrational and short-sighted decisions.
Wealth Grows In Silence And Is Lost In Noise
Wealth building typically does not happen overnight but rather over time. It essentially builds quietly and by being patient.
Wealth destruction, however, usually happens when we let ‘noise’ influence our behavior.
If we fixate on media and social media, we increase the risk of making irrational investment decisions.
Chase Certainty In An Uncertain Game
Nobody can consistently accurately predict share price behavior. Many investors, however, turn to investment pundits when market conditions sour in the hope of getting an answer of when market conditions will recover.
Although some market pundits may occasionally be accurate with their predictions, their track records are inconsistent. If these market pundits were consistently accurate, they would likely rank high on Forbes List of Billionaires.
When we consistently seek certainty, we increase the risk of making:
- panic-driven decisions to sell; or
- irrational decisions to prematurely ‘buy’ in the hope of ‘catching the rebound’.
The true testament of an investor is recognizing and accepting that we do not know what the future holds. In coming to grips with this, we build the mental fortitude to handle uncertainty.
The Best Investors Are Masters Of Their Own Minds
The best investors become this way because they control their emotions. They do not panic when markets plunge. They think rationally because they understand that investing is a mental game.
We must, therefore, train our mind to endure as opposed to permitting the market to train us to react.
Temporary Losses Become Permanent When We Lose Conviction
Warren Buffett’s two rules of investing are:
- Do Not Lose Money
- Do Not Forget Rule #1
We have no chance of recovering from share price declines if we panic and exit positions following a share price plunge. We must have the intestinal fortitude to withstand temporary pain.
In some cases, the investment should have never been made to begin with. Retaining exposure to a company following a share price plunge, therefore, only makes sense if we understand our investment and are confident the business can recover from its setback.
Liquidity Is Key
Liquidity gives us the freedom and luxury to capitalize on opportunities. When share prices are tanking and other investors are forced to sell at the worst possible time, you want to be in a position to take advantage of their misfortune.
Buying quality assets at a discount provide us with the opportunity to generate attractive investment returns.
Build Real Wealth During Downturns
Everyone looks like a hero when market conditions are favorable. Real wealth, however, is often built when panic sets in and share prices plunge. It is during these periods when you buy quality assets in advance of the inevitable market recovery.
Our Time Frame Shapes Our Reality
If your investment time frame is days/weeks/months and share prices plunge, your investment behavior is very likely to be far different from that of an investor who investment time frame is decades.
As an investor with a very long investment time horizon, negative short-term share price behavior does not prompt me to think about ‘bailing’ when the share price plunges for no justifiable reason.
My investment time frame extends beyond my lifespan. A stock’s price corrections will, therefore, likely look like a mere blip if I look the company’s stock chart 20+ years from now.
People Typically Want Rewards Without Pain
Making money through investing is appealing. Reality, however, is that investing comes with its fair share of pain.
The greater the probability of an outsized investment return, the greater the risk. This is the risk-reward trade-off.
Don’t expect double digit gains if you limit your investments to those that carry very little risk.
If you want to generate outsized investment returns, you need to have the intestinal fortitude to withstand a higher degree of risk. Such investments are apt to experience price volatility that would lead investors with a low risk tolerance to lie awake at night.
Ask any great investor who has been investing for a very long time if they have ‘battle scars’. They have undoubtedly experienced nerve wracking share price pullbacks. The reason they are great investors is because they stayed in the game; they knew that pain and suffering is the price for long-term success.
Unsuccessful investors, on the other hand, quit at the most inopportune time.
What You Survive Defines Your Future
Portfolios that survive major corrections are generally much stronger than those built on luck or leverage.
The ability to survive and endure the worst gives us the chance to thrive in the future.
We should, therefore, build a portfolio that will let us survive anything as opposed to building a portfolio to impress others.
Valuation Matters
Everyone loves a bargain. When stocks get cheap it is tempting to think share prices will recover shortly. The recovery time frame, however, is unpredictable.
There is a laundry list of companies whose share prices were bid up in 2020 but subsequently plunged; their respective share price is unlikely to reach the 2020 price any time soon.
Look at Zoom Communications (ZM). In mid-October 2020, its share price reached a high of ~$478. I bought 900 shares in 2023 and 2024 at an average cost of $63.34; the current share price is $82.50 as I compose this post. The company is much stronger than it was in 2020 yet I do not envision ZM’s share price returning to ~$478 any time soon.
Sentiment can sometimes drive short-term share price behavior more than the underlying fundamentals of the business. This is why it is so important to be patient and to know when a ‘good deal’ presents itself.
Sometimes we buy when shares are a ‘good deal’ but the share price subsequently drifts lower. In such instances, we need the temperament to hold what is undervalued even if it gets cheaper. If our underlying thesis for making the investment still holds, it sometimes even makes sense to increase our exposure!
Final Thoughts
It is critical that we master our mindset. Even if we are amazing investors and can consistently invest in the ‘right’ companies and perfectly time all our investment decisions, market conditions will experience periods of panics and euphoria.
Successful investors differ from the masses. They master their mindset, control their emotions, and stay the course when things get tough.
I wish you much success on your journey to financial freedom!
Note: Please send any feedback, corrections, or questions to [email protected].
Disclaimer: I do not know your circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your research and due diligence. Consult your financial advisor about your specific situation.
