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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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An investor drawn to that impressive performance would have been rewardedHow did the tech craze happen? Of course books couldand have been written on the subject. But the basic behavior was this: When people saw the prices of tech stocks rising so high so fast, they wanted a piece of the action. Individual and institutional investors alike bought in, thereby driving the prices of the stocks higher. Once the bubble began to burst in the spring of 2000, there was not enough in the way of fundamental valueearningsin these companies to support their wild prices. As swiftly as the prices rose, they collapsed. The Nasdaq closed out 2000 down 39 percent, and 2001 down 21 percent. From the high of March 10, 2000, to the end of 2001 the Nasdaq lost more than 70 percent of its value. In the most manic part of this period, it would have taken an incredible amount of courage to invest in anything but tech. Yet, unless you were one of the savviestand strongest willedinvestors, an investor who ducked out before the bottom fell out, youd probably would have been better off in almost anything but tech. To see why, lets compare two funds, First Eagle SoGen Global, an international stock and bond fund, and John Hancock Technology, a tech stock fund. In 1998, the Hancock tech fund returned 49.2 percent, an enviable return by almost any measure. An investor drawn to that impressive performance would have been rewarded in 1999 in spades, with an eye-popping 132.3 percent return. Meanwhile, SoGen lost 0.3 percent in 1998 and returned only about 19.6 percent in 1999. At that point a frustrated SoGen investor might have jumped ship. To what end? The Hancock fund lost over 37 percent in 2000 and another 43 percent in 2001. Meanwhile, SoGen returned about 10 percent both years doing far better than both the tech-laden Nasdaq index and the broader S&P (see Table 1.3). Over five years through September 30, 2002, SoGens annual return of 7.29 percent is significantly better than Hancock Techs 14.6 percent loss. Over 10 years through September 30, 2002, the compound annual returns were: 10.3 percent for SoGen versus 4.3 percent for Hancock. But through the decade SoGens returns were much steadier with substantially lower risk. There were no panics with SoGen. One wonders how many Hancock investors got into the fund just in time for the abominable results. The Hancock tale is not unusual. Take a look at the returns of several onetime outstanding performers in Table 1.4. Courage to stay your own course demands the ability both to pass on the current trends and to stand by the principles of your investing game plan. Of course, its tough to be courageous if your portfolio is in the tank. If your investments are sinking while your office mate is making a big hit in, say, biotech, you may feel more like a sucker than courageous. Thats why its important to choose a selection of investments thats likely to produce steady positive returns in any market environment. If you have a portfolio with investments that, while not necessarily hitting the top of the charts, are on the whole consistently doing well, youll be less tempted by the latest, greatest thing. Say, for example, one of your investments, a value fund, is not performing as well as growth stocks with high earnings expectations. Youre tempted to sell your value fund to buy some growth. If youve already got some growth in your portfolio, that growth fund will likely satisfy your itch and reduce the chances youll sell out of the value fund at its low, just before it may rebound. By having some growth and some valueby diversifying your investmentsyou are likely to earn returns that are more steady than spectacular. A burst in one area will be undermined by a lag in another. But its an approach that could make you more likely to behave in a way that will preserve those steady returns than if you were constantly trying to bail out of trailing investments and hop onto hot ones. Thats what diversification and allocation, which I discuss in Chapter 4, are all about. Its easier to turn your back to the trend when what youve got is doing just fine, thank you. If a game plan is at least doing what you expected it to do, then youll be better able to resist the temptation to sell out at a low or buy the trend at its high. A game plan worthy of your confidence should give you the courage to stand by it. The hardest thing to know, of course, is whether an investment is just in a temporary rut or it really was a subpar choice and you need to sell. I dont recommend blind buy and hold. In Chapter 9, I discuss reasons why at times you should cut the cord. That takes courage, too. But often the courage you need to muster is the courage to do nothing at all. The Three Cs, the Market, and Your Brain: A Challenging Trio If you still dont think commitment, consistency, and courage are important to your investing game plan, consider what theyre up against. Recent developments in neuroscience have underscored just how biologically primed our human brains are to want the fast buckand to overlook the risk of losing even more. Journalist Jason Zweig recently wrote in Money magazine about scientists growing understanding of how investors brains work.2 By learning about the preprogrammed mechanisms that can fuel common investing mistakes, he argued, we take one step closer to circumventing them. I agree. So what should you know about your brain? Here are some of the recent findings that Zweig explored: Fight or Flight. For starters, the amygdala in the forward lower area of the brain responds with lightning speed to perceived threats. This was helpful when we were hunter-gatherers running from predators. But, as investors, the panic that ensues can derail a long-term investing strategy. That said, the memory of the fear and anxiety created by the amygdala may also be helpful, as it makes investors more cautious. Experiments by neurologist Antoine Bechara of the University of Iowa have indicated that people with damaged amygdalas never learn to avoid making riskier choices. It makes sense, then, Zweig pointed out, that investors accustomed to only the bull markets of the 1990s (and no past memories of fear to measure danger against) made too many risky choices. Primed to Predict. Thanks to two areas of the brain, the nucleus accum bens (at the bottom surface of the front of your brain) and the anterior cingulate (in the central frontal area), humans cant help themselves when it comes to patterns. It seems were always looking for them in the world around us. We respond unconsciously, Zweig says. Scott Huettel, a neuroscientist at Duke University, found that our brains expect a repetition after a stimulus occurs only twice. Fear and anxiety often occur when a repeat pattern is broken. This may explain why investors jump out of previously predictable companies when they miss earnings forecasts, Zweig says. The Dopamine Buzz. Dopamine is the brain chemical that gives you that euphoric feeling when you win big. It may come as no surprise that a team of scientists led by Harvards Hans Brieter found a similarity between the brains of people trying to predict a future financial gain and the brains of cocaine addicts. Eventually investors get higher from the rush of dopamine they get when predicting a win than from the win itself, Zweig says. If the gain doesnt arrive, that euphoria quickly turns into depression. How to harness all this knowledge? Zweig rightly points out that the science makes clear how important good, irreversible investing habits are to neutralizing the brains propensities. Getting a disciplined game plan mind-set, then, is crucial to winningand triumphing over biology. Step 1, then, is not about calculating long-term financial needs or analyzing mutual fund returns. Its about getting the game plan mind-set. You cant turn it on like a switch. But youve got to start somewhere. Begin to think about the three Cs, and keep them in mind throughout this book. Eventually they will form a belief framework that will serve you well throughout your investing life. |
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