The Challenges of Investing

The emotional side of investing
All investors have to deal with two contradictory emotions: the fear of losing money and the desire to make money. Which emotion dominates often depends on the state of the market.

In rising markets, it is tempting to focus on gains. With optimism all around, both greed and the fear of being left behind are in play. The fundamentals are easily forgotten and confident projections of the gains to be had easily justify participating in the trend of the moment. Then trend reversals come as a surprise.

In declining markets, fear comes to dominate. The focus becomes the extent of the price decline and deep concern about how much further down prices could go. Again, fundamentals are ignored and alarmist projections take hold, this time justifying sales at a big loss to “protect” what capital is left. The realization that the losses did not have to be taken comes later, when the market corrects its excesses.

Dealing with emotions: relative performance

Fear and greed are difficult to handle. One way to deal with the difficulty is to compare how well one is doing against the market. However, using relative performance as a test of investment acumen has a price. Trying to match or beat the market leads to a focus on short term results, precluding investments that may take time to mature. It also incites comparisons with other investors’ reported successes, leading to participation in current market fads out of fear of “missing out” and distracting the investor from the fundamentals of successful long-term investing.

Successful investing: choosing a method
In the end, successful investing depends on others being willing to buy later at a higher price what one bought earlier at a lower price. Investors have a choice to make as to the method they will employ.

  • Forecast based investing
    Most investment methods can be described as the building of a “system” relying on many factors to predict how prices will likely move, usually in the short to medium term. Success will then depend on the ability to buy before others can figure out the same. Such systems may rely on sophisticated forecasts based on economic analyses, mathematical models or past historical data, or may try to gauge the fear and greed of others to predict their actions in their chase for short term profits.
    The reality, of course, is that anything can happen tomorrow, including the unpredicted. Every day, financial markets reflect the actions of millions of investors whose ideas – and mood – keep changing with the news cycle and unforeseen events.

  • Investing as business ownership
    The other method is to consider each investment as a fractional ownership in an underlying business that can be assessed and valued. By assessing and valuing the business today, a current business-based value for the related security can be established and compared to its market price.
    This business-based value can be relied upon to build an investment strategy that will not depend for success on accurately predicting other investors’ future psychology: Intrinsic Value Investing.
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