Investing is a psychological exercise as much as it is a financial one. You give away your real cash to own a share, a sliver of ownership that you can't see, in hopes that you will earn a return from future earnings and a higher share price.
You have to be confident in what you buy, and that means you need to know it as well. After you purchase shares, then comes the test of the will. To invest intelligently, you have to strengthen yourself against four "enemies" — hope, fear, greed and regret.
When it comes to investing, hope colours our decision to act decisively. We buy a stock, and later the story get worse, but we hope that it will recover. The thinking is that if we don't sell, then the loss isn't real, but that paper loss can grow into a bigger one.
QBE Insurance Group (ASX: QBE) was a market darling in 2004-2007, rising from $10 to $36, The GFC came, and wiped that away. People who bought at the higher points held onto it in case it would recover back to the where they bought so at least they could recoup their loss. It didn't happen. The stock eventually slid back to $10.
Fear comes from the depths of a bad situation, like the low point of the GFC when the US S&P 500 Index (NYSE: SPX) effectively halved in value. Not knowing how far down the market could go, people sold off good company stocks at bargain prices just to get out. Instead, they should have been buying even more at a cheaper price in a good business.
The other emotion that drives markets is greed — the chance to make "easy money". The concept of intrinsic value is completely lost in the froth of market exuberance, so you pay much more than you should because "this time is different", or it's a sure-fire decision. Oil Search (ASX: OSH) has had a great run over the past 10 years, from $1 a share to currently $8.70. Its price-earnings (PE) ratio is around 64. It may still have the ability to grow next year's earnings, but if it shows weakness, the share price will fall quickly. Greed can make you forget that price is what you pay, and value is what you get.
Finally, regret may keep you from buying back into a company you once owned and lost money in. An intelligent investor will review the situation, and if it looks like the company has recovered, and the story has improved, then a sound investment shouldn't be ignored.
Regret stays our hand, and later on when the share price has recovered well past our initial purchase price, we feel more regret for not considering a new position. If you sold your REA Group (ASX: REA) shares at $5 in 2009, only to see them rise to $15 in 2012, you may have said to yourself that you missed your chance. Had you re-examined the company and its reports, you would have seen that same story was getting better, and you would have started a new position. Since August 2012, the share price has risen past $41, and soon will be another three times up if it hits $45.
These emotions make us do the opposite of what we should do if we are to invest as a businessperson. The seemingly cold way of looking at companies will keep you in stories that are improving, and get you out of troubled companies before too much is lost.
Writing your thoughts in an investment journal is one good way to look at the reality of your decision making, and not get caught up in the emotion. You have a document showing you why you bought, and when those reasons are no longer the case, then you will act most intelligently. A good story stays good as long as it does.
Think about your own total return and find out about companies with good dividends. Discover The Motley Fool's favourite income idea for 2013-2014 in our brand-new, FREE research report, including a full investment analysis! Simply click here for your FREE copy of "The Motley Fool's Top Dividend Stock for 2013-2014."
- Fortescue to focus on cutting debt rather than growth
- 7% yields on offer from property groups
- Insurers face bush fire claims
Motley Fool contributor Darryl Daté-Shappard does not own shares in any company mentioned.