Investors are strange individuals.
They go against the grain and against the crowd, and these differences make them stand out.
This blog will explore some of the psychological challenges of being an investor, and attempt to provide strategies to avoid falling for some investment pitfalls.
Please note that any information supplied on this website is for entertainment purposes only and should not be taken as financial advice. Any reader should do their own research and/or consult with a qualified financial advisor.
The Contrarian Nature of Investors
Going Against the Grain
Contrarian thinking is to go against the crowd.
Perhaps Warren Buffett summed this up best when he stated, “Be fearful when others are greedy and greedy only when others are fearful.”
Although this statement seems logical, anyone who has been in the markets for an extended time understands how terrifying it can be to watch stocks fall.
I remember as if it were yesterday how everyone reacted to the 2008 financial crisis – it seemed as if the sky were falling. Yet investors such as Buffett, and Carl Icahn were able to pick up valuable assets at discounted prices.
In my own experience, I bought many stocks during the COVID-19 pandemic and profited greatly from them, despite taking a hit on many of my REITs (I had invested in malls).
Overall, I was able to make a profit net of losses.
Another key factor in contrarian thinking is to beware of trends. Although there are huge rewards if you can grab hold of a trend on the way up, there is considerable downside risk if a thesis does not play out.
Many great investors seem happy to ignore trends altogether and do not get caught up in the dreaded FOMO (fear of missing out).
Currently, there is a lot of AI hype that has been pushing the large-cap stocks in the S&P 500 upwards.
Even if the hype is justified, is there enough reason to invest in these large caps?
There is so much downside risk and probably easier opportunities in the market. Also, there will be other players that benefit from AI developments at less premium valuations, such as Alibaba.
Psychological Challenge: Herd Mentality
Herd mentality is one of the key psychological barriers that great investors have to overcome.
Your friends, family, colleagues, the UBER driver, and your golf caddy will all be giving you recommendations.
We have a psychological need to feel like part of a group, and there is always a pressure to conform.
Thinking differently requires mental fortitude, confidence in your abilities, and frameworks for thinking.
Practising saying “no”, is a key component of this challenge. If you struggle to say “no” and set boundaries in your life, you may struggle to build the mental fortitude to survive the markets.
Another useful way to avoid following the herd is to use a framework. If potential investments need to pass specific filters to be considered this can prevent you from making impulsive decisions.
Averaging into the market and automating investments is also a great way to invest with little time to research. If you set up your investments well, you can concentrate on other aspects of life and allow your portfolio to grow in the background.
As one of the greatest investment risks is exiting the market early and at a loss, it often makes more sense to manage investments passively, rather than actively.
Charlie Munger stated, “It’s waiting that helps you as an investor, and a lot of people just can’t stand to wait.” (source)
Managing Emotions: Fear and Greed
Fear and greed are the primary drivers of market irrationality. Mispricing occurs when investors become overly enthusiastic about a company’s prospects, leading to inflated valuations driven by greed. Conversely, excessive fear causes downward mispricing as investors panic.
Market participants interpret news—both positive and negative—through a subjective lens, often leading to incorrect conclusions. While some price movements are justified by new information, these reactions can be exaggerated.
Successful investors must remain calm and analytical, carefully evaluating the information. Sometimes, the data is clear and provides a strong indication of the company’s future, but it requires a level-headed approach to distinguish these signals from market noise. Aim for value rather than price!
The Fear and Greed Index, developed by CNN, aggregates seven market indicators to measure overall market sentiment. These indicators include stock price momentum, price strength, price breadth, put and call options, market volatility, haven demand, and junk bond demand.
Key Indicators:
- Stock Price Momentum: S&P 500 vs. 125-day moving average.
- Stock Price Strength: Number of stocks hitting 52-week highs vs. lows.
- Stock Price Breadth: Volume of shares in advancing vs. declining stocks.
- Put and Call Options: Trading volume of puts vs. calls.
- Market Volatility: CBOE Volatility Index (VIX).
- Safe Haven Demand: Stock returns vs. Treasury bonds.
- Junk Bond Demand: Spread between junk and investment-grade bond yields.
Purpose:
Strategy Adjustment: Guides investment strategy based on sentiment.
Market Sentiment Gauge: Provides a snapshot of market emotions.
Contrarian Indicator: Extreme fear may signal buying opportunities; extreme greed might indicate a market top.
Risk Management: Helps gauge market risk levels.
The Fear and Greed Index is a useful tool for gauging overall market sentiment. Extreme greed can indicate opportune moments to exit positions, while extreme fear may present buying opportunities.
However, it’s essential to base purchasing decisions on fundamental analysis rather than assuming a stock is a good buy simply because its price has dropped.
Long-Term Perspective vs. Short-Term Fluctuations
Taking a long-term view is essential, especially if you tend to seek instant gratification in other areas of your life. Investing is fundamentally about patience, discipline, and long-term decision-making. It requires a mindset shift from chasing quick dopamine hits to cultivating a deeper, more sustainable approach to building wealth.
Working on Your Psychology
Perhaps you struggle with making long-term decisions, opting instead for short-term pleasures. If this sounds like you, investing will naturally be a challenging path. To succeed as an investor, you need to develop the mental resilience to withstand market volatility and avoid impulsive decisions.
Investing is a marathon, not a sprint. It’s about holding your ground through market ups and downs. By understanding the long-term benefits of investing, you can train yourself to be more patient and less reactive.
Think of investing like buying a business. You wouldn’t purchase a company on a whim; you’d take the time to analyse its potential, understand its financials, and evaluate the risks. Apply the same diligence when buying stocks.
Take the time to research and understand what you’re investing in. I have noticed that in my journey if I have taken the time and have conviction in my holdings, I’m not bothered by the short-term fluctuations – I may even invest more into a position as it moves down.
Self-Improvement Through Investing
Investing is not just about growing your wealth; it’s also a journey of personal growth. It teaches you to be patient, disciplined, and thoughtful.
By working on your psychology and understanding the importance of long-term thinking, you become a better investor and develop valuable life skills.
I can say that honestly, every bad decision I’ve made in my life has been the result of short-term thinking rather than concentrating on the long-term.
Analysis Paralysis
Whilst this has not been something I have struggled with in my investment life, overanalysing can be so easy to do when you have access to so much data.
Over time, you learn that certain characteristics in business matter.
Some aspects that I regard as particularly key are return on invested capital, debt and debt maturities, price to free cash flow, and net profit margins.
Allowing yourself to make mistakes is the key to this behavioural barrier. Making mistakes and then learning from them is how you ultimately grow.
Final Thoughts
Investors stand out by going against the grain, demonstrating a contrarian mindset. As Warren Buffett said, “Be fearful when others are greedy and greedy only when others are fearful.” While this is logical, it’s tough during market downturns. Successful investors often buy undervalued assets during crises.
Chasing trends is risky. Great investors avoid FOMO and focus on fundamentals. Current AI hype may not justify high valuations, revealing better opportunities elsewhere.
Resisting herd mentality requires mental strength and a solid strategy. Using investment filters and automating contributions helps manage emotions and avoid impulsive decisions.
Fear and greed drive market mispricing. Successful investors stay calm and analyze vital information. The Fear and Greed Index helps gauge sentiment, indicating when to buy or sell based on market extremes.
Investing demands patience and discipline, focusing on long-term gains. Treat it like buying a business—invest after thorough analysis.
Investing also fosters personal growth, teaching patience and thoughtful decision-making. Embrace long-term thinking to improve as an investor and develop valuable skills.
Focus on key metrics like return on invested capital and free cash flow. Overcoming overanalysis involves accepting mistakes as part of the learning process.
Understanding these aspects helps you navigate the investment landscape effectively, becoming a more disciplined and successful investor.
