Pain is a great teacher. The threat of pain is a great motivator. Behavior in every aspect of human endeavor has been shaped by a desire to avoid pain: legal compliance, romantic relationships, political compromise, etc. It’s a basic, fundamental element of being human. Unfortunately it sometimes backfires.
Let’s examine a few painful motivators for investors and how they are typically mismanaged:
- Running out of money in old age. This is the reason most people are willing to risk capital in unpredictable markets. They need growth to avoid their fears of retirement poverty from becoming reality. Investors often assume that the market will always go up in the long term and that being patient will automatically result in a positive return. Conversely, the threat of running out of money someday is the same fear that causes people to miss out on long bull markets due to their eternally pessimistic interpretation of the news. In both cases, the threat of pain is reasonable but the actions are naive and potentially devastating.
- Paying taxes. Nobody likes paying taxes. Unfortunately, fear of this pain often becomes the tail that wags the dog. I have seen investors allow substantial gains to evaporate completely because they were loathe to sell and pay part of the profit in capital gains tax. I have also seen investors allow losses to mount and then rationalize their inaction with the excuse of being able to use the loss against a gain sometime in the future. Taxes are an important component of investing, but not the most important.
- Being wrong. This one has been beaten to death in earlier articles but it can’t be stressed enough. While nobody reasonably expects investment perfection, most investors still have a difficult time taking losses when they should – while they’re small and manageable. Resistance to throwing in the towel on a losing position is often the result of too much ego getting mixed up in the decision making process. Getting comfortable with and planning for this pain is crucial.
- Paying fees. Unnecessary expenses are always a bad idea. The trick is in deciding what is necessary and what isn’t. A bit of introspection is valuable here. If an advisor or broker can make decisions and enforce discipline that is difficult for an investor to do on his own, the expense is likely worthwhile.
- Lagging a benchmark. This is more hypochondria than actual pain, but people tend to worry about it. The truth is, under performing an index doesn’t matter. It’s a made up concern. You don’t invest to match an abstract method of tracking a particular market – you invest to make money. If you can grow your money at an adequate clip within a sound method of managing risk, you’re investing successfully. Beating or lagging a benchmark simply doesn’t matter.
If you can define your top two or three biggest sources of investment pain, your strategy just got simpler. The threat of that pain should motivate and clarify the actions you need to take right now to get comfortable.