Our brains are not naturally wired for trading or investing.
We are built for simpler things. Hunting, farming, building, and raising children.
So the modern investing landscape can be a nightmare for the human psyche.
Today we have the ability to trade nearly any asset, instantly, for free. For a fee, we can use leverage in the form of margin or options.This is a remarkable technological achievement, but also dangerous.
In this world, our brains are often our worst enemy.
First of all, our minds tend to hyper-fixate on losses. Even when our portfolios are up, if they dip from an all-time high, we focus on that drop instead of the bigger picture.
And whenever our portfolios reach a new high watermark, our brains imprint that as our new updated net worth.
God forbid it falls from that high, because our brains start scheming about how we can get back to that number. It's important to realize that mistakes are inevitable, and timing the market perfectly is impossible.
Today, let's talk about how to rewire our brains to make more money. And do it with less stress.
Many people use the terms trading and investing interchangeably. This is a mistake.
Investing is a long-term strategy, while trading is short-term.
It's my strong belief that the majority of an investor's portfolio should be held in assets they plan to hold for years. The longer the better.
The main reason is simple. Timing the market is really difficult. And our brains don't handle volatility well. If you're trading based on emotion, you're likely to buy high and sell low. It's just how our brains operate by default.
We must consciously override these bad instincts. And the easiest way to do that is to adopt a buy-and-hold approach for the bulk of our assets.
Investing for the long run is also far more tax efficient, as we covered a few months back.
Of course, that doesn't mean we can't trade too. I have a portion of my portfolio reserved for short-term trades, mostly using options. But it's a relatively small slice.
If you tend to trade impulsively, it probably makes sense to separate your trading and investing accounts. One account, with the bulk of assets, for long-term investments. And one account just for trading and options.
This makes it far easier to track the performance of each strategy and adjust accordingly.
Our minds also tend to watch what others are doing, and copy whatever's making the most money. This describes every asset bubble in history.
One of the primary ways our brain can betray us is when we hear a story about some huge gain and attempt to chase it.
Dotcom stocks in 1999. Housing in 2007. Hot U.S. stocks today. Don't get me wrong, you can make money from bubbles. But it's important to go into it fully aware of the risks, and avoid taking unnecessary risks.
For example, my father-in-law worked for the Secret Service for 30 years. During the late 1990s, he kept hearing about how much money his co-workers were making in tech. He decided to join the party in 1999, near the peak. He invested far too much, using leverage, in the hottest stocks on the market.
He got burned so badly that he never invested another dollar in the stock market. He stuck to CDs for the rest of his life, at a time of record low interest rates.
His mistakes were that he abused leverage and had no diversification. If he had also owned a S&P 500 index fund, some gold, and international stocks, the pain would've been manageable. He could have stayed invested in the market for another 25 years and multiplied his money many times over.
But he saw how much money guys around him were making, and fell in love with the idea of making those returns too. After the bubble burst, he was so scarred from the experience that he missed out on another 2+ decades of returns.
As investors, our primary job is to position ourselves in stocks and sectors that we expect to perform well for years to come. Right now I believe the best bets are precious metals, miners, and cheap emerging markets like Brazil. But I also have exposure to U.S. stocks through retirement funds, and some venture capital investments as well.
Diversification remains key, and for me that means a healthy dose of alternative assets like gold, silver, natural resource stocks, and emerging markets. Most of us have plenty of exposure to the American economy through our jobs, retirement accounts, and even our houses.
I view trading as a secondary objective. A portion of our portfolios reserved for swinging for the fences. Unless you're a proven trader, it's best to seek guidance from experts like those we have on staff here at Paradigm.
The most important thing we can do as investors and traders is to override our brain's natural instincts. Do not let emotion run your portfolios. That's a bad path to go down.
For the long-term section of your portfolio, find assets you're comfortable holding for 5-10 years. Making a plan and sticking to it is one of the most important parts of becoming a successful investor. If you're constantly rotating your entire portfolio, the chances of making solid returns over the long run goes down substantially.
Build a good thesis and stick with it. If you can do that, you'll be ahead of the vast majority of investors (and traders!).
The Daily Reckoning