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Acknowledge your emotions to grow your capital faster

Since I read the suggestion in The Manual of Ideas a few months ago, the idea that investors should cast themselves as capital allocators has been constantly bumping around my mind. Author John Mihaljevic argues that such a mindset helps him focus on the underlying business and take a long-term view.

According to Mihaljevic, the capital allocator’s role in a properly functioning capitalist system is to “foster the allocation of capital to productive uses while minimising frictional costs and enabling other industries to deliver goods and services”. Frequently changing one’s mind – buying and selling frequently – increases frictional costs, and continues to be one of my weaknesses as a capital allocator.

One example of capital allocators doing a good job can be seen in the flow of funds away from Fairfax Limited (ASX: FXJ) towards Seek Limited (ASX: SEK) over the last decade. Seek clearly has a more efficient way of advertising and searching for jobs, with lower frictional costs for everyone. I just hope that Fairfax won’t lose the quality journalism as its financial situation worsens.

The capital allocator’s role in deciding what companies are worth owning (or funding) does not strip them of their humanity. No sane person can argue that either share markets, or the individuals making them, are rational all the time. Traditionally, market participants are said to be impacted by greed or fear.

I think the emotions impacting market prices are far more complicated. Other important influences on financial decisions include affinity, disaffinity, anger, hope, denial, guilt and envy. Envy is said to be more important than greed in bubbles. As the months of positive investment returns add up, envious new capital allocators begin to borrow against the future to get in the game today. By recognizing the full gamut of emotions, capital allocators can adjust for them consciously and make more rational decisions.

I admit that my affinities influence my investment decisions because I prefer to allocate capital to (what I perceive as) worthwhile causes. While I admire the impressive return on investment achieved by CSL Limited (ASX: CSL), I also like the fact that the company pays its employees to invent, manufacture and supply life-saving and pain-alleviating treatments. I can’t be sure, but I think it’s a good bet the company is making the world a better place. My affinities can influence my decisions in ways that can have both positive and negative impacts on my returns.

Foolish takeaway

I’m trying to think of myself as a capital allocator from now on. If nothing else, it will encourage a long-term view, and emphasise that I’m investing in a business with an uncertain future, not a stock ticker and a backwards-looking Appendix 4D (a half-yearly report).

In a recent interview on Ten Bags Full, boutique fund manager Dean Mico shared this insight: “By buying shares, you learn a lot about yourself such as your risk tolerance and level of patience. This knowledge can help new investors develop their own style.” I too think self-knowledge is key to improving as a capital allocator. It would be irrational to think we are always rational.

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Motley Fool contributor Claude Walker (@claudedwalker) does not own shares in any of the companies mentioned in this article. He welcomes correspondence from other capital allocators.

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