The Mind of an Investor
Overview
This module will lead us to understand how investors think. It aims to highlight the attitudes and mindsets we can adopt in order to become wise investors.
As we learnt in the previous module, investing is a long-term journey rather than one of instant rewards. Let us take the time to understand how to make our future financial goals a priority.
By the time you have completed this module, you should have a better understanding of the kind of mindset you need in order to shape your long-term investment journey.
Set Goals
An investor first understands why they are investing their money and the result they desire in the long-run from doing so. This is called having financial goals.
It may be worthwhile to ask yourself vital questions such as:
- What are your intentions for the funds that you would like to invest?
- Is safety as the main goal with some degree of return adequate?
- Is your objective to accumulate money for a longer-term goal such as a tertiary education for your children or maybe a more secure retirement for yourself?
You may even have various investments for different goals. Remember to create these goals with an understanding of how much risk you can handle and your time horizon.
Understand Your Level of Knowledge
It is vital for an investor to understand what they do and don’t know. They should never be talked into investing in something that they are not comfortable with or do not understand.
Some investment vehicles need advanced knowledge and observation, while others are much simpler and allow you to just invest and go. Your investment decisions need to be established on your level of comfort and your willingness to dedicate time to investigating your choices.
The key is to continually work on improving your level of knowledge through vehicles (tools) such as books, internet research, seminars and workshops which will assist you in improving your investment knowledge in order to make better investment decisions.
Avoid Panic
Panic is an emotion that causes us to make irrational decisions - to sell a share when it should be held, or to buy a share when perhaps it should be sold.
The reality is that we are not able to stop our emotions from rising, including panic, but we can learn to control them. You can learn to use the emotion of panic to lead you to do more thorough research and to become a better investor.
Finally, try to take bad market news in your stride and make sure you have analyzed a situation properly before acting. If you choose to delay an investment decision by even a few minutes, your thought process can become noticeably clearer.
Consider Short-term Wins
Investors are encouraged to invest for the long-term but they need to consider the possibility that certain events could positively or negatively impact their investment. They need to use that information to help them in making a decision of when to buy.
For the sake of an example we are going to consider the investment decisions made by an investor buying in to a fictional gold mining company, AU.
A long-term investor bought shares in AU in early 2005 because the shares looked "cheap". What they didn’t consider was the near-term risks that come with strikes that were happening at the time and how the break in production would affect the share price of AU. The investor ended up losing 50% of the value of their investment within a year.
Had that same investor considered what was happening in the mining industry and waited until the shares leveled off in the spring of 2006 before buying in, his or her investment would have been up about 30% by the end of the year.
An investor, therefore, keeps in mind the possibility of short-term catalysts that could impact shares.
Understanding Your Risk Appetite
It is important for investors to understand what risks they are willing to take in their wealth creation journey. You should have a realistic understanding of your ability and willingness to handle large changes in the value of your investments. If you take on enormous risk, you may panic and sell at an inopportune time. The following questions can assist in deciding the risks an investor is willing to take:
- What products am I going to invest in? For example, single stock options vs FTSE/JSE Top 40. It would be useful to get an idea of the worst-case returns that different products have had in the past so you can decide how much money you would be willing to lose if you invested in a certain product and it had a period of bad performance.
- What products am I willing to lose or let go of should the need arise?
- How long am I willing to sit in a losing position when my investment seems to be faltering? Will I ride it out or pull out?
It is important for an investor to know when to cut their losses.
An investor needs to always have a position to fall back on whether it is deciding on the maximum percentage drop in value of their shares below purchase price that they are willing to take. They should also always have a way out of an investment position or a way to understand and reduce their risk.