8 ways to tame your brain
The investing world is full of traps and our brains are wired to lead us into them.
(Money Magazine) -- Most investors think too much and end up making the wrong moves. Follow these 8 guidelines and make the right ones.
Avoid the "sure thing"
Your "seeking system" is especially turned on by the prospect of a big score, and that in turn will hinder your ability to calculate realistic odds for the success of an investment.
Be on your guard against any sales rep who tries to lure you with jackpot jargon like "can't miss," "double your money" or "the sky's the limit."
Remember: lightning seldom strikes twice
If you've ever had the taste of a big gain, you'll likely be tempted to try to get that feeling back. So be especially wary of investing in stocks or mutual funds that remind you of the one you made a killing on long ago; chances are, any similarities to another investment, living or dead, are purely coincidental.
Making a financial decision while you're inflamed by the prospects of a big gain - or a huge paper loss - is a terrible idea.
Calm yourself down (if you don't have kids to distract you, take a walk around the block or go to the gym) and reconsider when the heat of the moment has passed.
Get away from the herd
If you are part of an investment organization, appoint an internal sniper whose job is to shoot down ideas everyone likes. (Rotate this role to prevent one person from becoming universally disliked.)
Similarly, if you're at a barbecue and your friends are talking up a seemingly great opportunity, speak to someone you respect who isn't part of the group before you jump in.
Lock up your "mad money"
Put at least 90% of your stock money into a low-cost, diversified index fund that owns everything in the market. Put 10%, tops, at risk on speculative trades. Be sure this "mad money" resides in a separate account from your long-term investments; never mingle them. Never add more money to the speculative account. (It's especially important to resist that temptation when your trades have been doing well.)
If you get wiped out, close out the account.
Control your cues
The stock market generates signals that can goad you into trading. Try watching CNBC with the sound off so that none of the hullabaloo about what the market is doing this second can distract you.
If you walk past the local brokerage firm every day so you can sneak a peek at the electronic ticker, take a different route. If you obsessively check a stock's price, use the "history" window on your browser to count how many times you've updated the price that day. The number may shock you.
Use your words
While vivid sights and sounds - say, red down arrows and scenes of mayhem on the exchange floor - fire up your emotions, the more complex cues of language activate analytical areas of your brain.
To prevent your feelings from overwhelming the facts and leading you to sell in a panic, ask yourself:
- Other than price, what's changed?
- Are my original reasons to invest still valid?
- Shouldn't I like this investment even more now that it's cheaper?
Track your feelings
Many of the world's best investors have learned to treat their own feelings as reverse indicators: Excitement becomes a cue that it's time to consider selling; fear tells them they should be thinking about buying.
I once asked renowned fund manager Brian Posner of Fidelity and Legg Mason how he sensed whether a stock would be a moneymaker. "If it makes me feel like I want to throw up," he answered, "I can be pretty sure it's a great investment."