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The 7 Deadly Sins Of Investing

Tyler Durden's picture




 

Submitted by Lance Roberts of STA Wealth Management,

I have often written about the emotional and psychological factors that inhibit long-term investment performance (most recently here). Despite repeated studies that suggest investors should just buy "passive index" funds and "hold on" until eternity, the reality is that it simply does not work that way.

If you were raised in a religious household, or were sent to a Catholic school, you have heard of the seven deadly sins. These transgressions -- wrath, greed, sloth, pride, lust, envy and gluttony -- are human tendencies that, if not overcome, can lead to other sins and a path straight to the netherworld.

In the investing world, these same seven deadly sins apply. These "behaviors," just like in life, lead to poor investing outcomes. Therefore, to be a better investor, we must recognize these "moral transgressions" and learn how to overcome them.

The 7-Deadly Investing Sins

 

Wrath – never get angry; just fix the problem and move on.

Individuals tend to believe that investments that they, or their advisor, make should "always" work out. They don't and they won't. Getting angry about a losing bet only delays taking the appropriate actions to correct it.

"Loss aversion" is the type of thinking that can be very dangerous for investors. The best course of action is to quickly identify problems, accept that investing contains a "risk of loss," correct the issue and move on. As the age-old axiom goes: "Cut losers short and let winners run."

 

Greed – greed causes more investors to lose more money than at the point of a gun. 

The human emotion of "greed" leads to "confirmation bias" where individuals become blinded to contrary evidence leading them to "overstay their welcome."

Individuals regularly fall prey to the notion that if they "sell" a position to realize a "profit" that they may be "missing out" on further gains. This mentality has a long and depressing history of turning unrealized gains into realized losses as the investment eventually plummets back to earth.

It is important to remember that the primary tenant of investing is to "buy low" and "sell high." While this seems completely logical, it is emotionally impossible to achieve. It is "greed" that keeps us from selling high, and "fear" that keeps us from buying low. In the end, we are only left with poor results.

 

Sloth – don’t be lazy; pay attention to your money because if you don’t – no one else with either.

It is quite amazing that for something that is as important to our lives as our "money" is, how little attention we actually pay to it.  Not paying attention to your investments, even if you have an advisor, will lead to poor long term results.  Portfolios, like a garden, must be tended to on a regular basis, "prune" by rebalancing the allocation, "weed" by selling losing positions, and "harvest" by taking profits from winners.

If you do not regularly tend to a portfolio, the bounty produced will "rot on the vine" and eventually the weeds will eventually reclaim the garden as if it never existed.

 

Pride – when things are going good don’t be prideful – pride leads to the fall. You are NOT smarter than the market, and it will "eat you alive" as soon as you think you are.

When it comes to investing, it is important to remember that a "rising tide lifts all boats." The other half of that story is that the opposite in also true. When markets are rising, it seems as if any investment we make works; therefore we start to think that we are "smart investors." However, the reality is that there is a huge difference between being "smart" and just being "along for the ride."  Ray Dalio, head of Bridgewater which manages more than $140 billion, summed it up best:

"Betting on any market is like poker, it's a zero-sum game and the deck is stacked against the individual investor in favor of big players like Bridgewater, which has about 1,500 employees. We spend hundreds of millions of dollars on research each year and even then we don't know that we're going to win. However, it's very important for most people to know when not to make a bet because if you're going to come to the poker table you are going to have to beat me."

 

Lust – lusting after some investment will lead you to overpay for it.  

"Chasing performance" is a guaranteed recipe for disaster as an investor. For most, by the time that "performance" is highly visible the bulk of that particular investments cyclical gains are already likely achieved.  This can been seen in the periodic table of returns below from Callan:

 Periodic-Table-Returns-090914

 I have highlighted both the S&P 500 Growth and Emerging Market indexes as an example. Importantly, you can see that investment returns can vary widely from one year to the next. "Lusting" after last year's performance leads to "buying high" which ultimate leads to the second half of the cycle of "selling low."

It is very hard to "buy stuff when no one else wants it" but that is how investing is supposed to work. Importantly, if you are going to "lust," "lust" after your spouse – it is guaranteed to pay much bigger dividends.

 

Envy – this goes along with Lust and Greed

Being envious of someone else’s investment portfolio, or their returns, will only lead to poor decision-making over time. It is also important to remember that when individuals talk about their investments, they rarely tell you about their losers. "I made a killing with XYZ. You should have bought some" is how the line goes. However, what is often left out is that they lost more than what they gained elsewhere.

Advice is often worth exactly what you pay for it, and sometimes not even that. Do what works for you and be happy with where you are. Everything else is secondary, and only leads to making emotional decisions built around greed and lust which have disastrous long term implications. 

 

Gluttony – never, ever over-indulge. Putting too much into one investment is a recipe for disaster.  

There are a few great investors in this world than can make large concentrated bets and live to tell about it. It is also important to know that they can "afford" to be wrong - you can't. 

Just like the glutton gorging on a delicious meal – it feels good until it doesn’t, and the damage is often irreversible. History is replete with tales of individuals who had all their money invested in company stock, companies like Enron, Worldcom, Global Crossing; etc. all had huge, fabulous runs and disasterous endings.

Concentrated bets are a great way to make a lot of money in the markets as long as you are "right." The problem with making concentrated bets is the ability to repeat success. More often than not individuals who try simply wind up broke.


Regardless of how many times I discuss these issues, quote successful investors, or warn of the dangers – the response from both individuals and investment professionals is always the same.

“I am a long-term, fundamental value, investor.  So these rules don’t apply to me.”

No you’re not. Yes, they do.

Individuals are long term investors only as long as the markets are rising. Despite endless warnings, repeated suggestions and outright recommendations - getting investors to sell, take profits and manage portfolio risks go unheeded.

Investor-Psychology-Cycle-062414

Unfortunately, by the time the fear, desperation and panic stages are reached, it is far too late to act, and I will only be able to say that I warned you.

 

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Tue, 09/09/2014 - 16:50 | 5199211 Rainman
Rainman's picture

I got 6 out of 7, that's pretty good.

Tue, 09/09/2014 - 17:05 | 5199266 Brutlstrudl
Brutlstrudl's picture

8 will kill you.

Tue, 09/09/2014 - 16:50 | 5199213 ebworthen
ebworthen's picture

When the markets themselves are the embodiment of those seven sins it is hard to justify investing at all.

Tue, 09/09/2014 - 17:08 | 5199275 Downtoolong
Downtoolong's picture

Exactly, that curve is a response to those seven sins, not the cause.

P.S. They left out sin 8, listening to Cramer.

Tue, 09/09/2014 - 16:51 | 5199214 RaceToTheBottom
RaceToTheBottom's picture

While they may be the Seven Deadly Sins to investing they are the Seven Entry Level Requirements for Banksters

Tue, 09/09/2014 - 16:50 | 5199217 Stoploss
Stoploss's picture

Thanks for the optical hemorrhage.

Tue, 09/09/2014 - 17:24 | 5199322 Tall Tom
Tall Tom's picture

What? Did you get Ebola?

 

People who get Ebola will have optical hemorrhage.

 

Other than that this article forgot the worst deadly sin of them all...DISHONESTY. Do not seek an ill gotten gain.

 

When the market is filled with FRAUDULENT INFORMATION and everyone is playing on the tilted deck of a sinking ship then it matters not if you have a first class cabin.

 

I will get on the lifeboat and not participate in the fraud at all.

Tue, 09/09/2014 - 16:51 | 5199218 q99x2
q99x2's picture

I've done very very well with crypto-currencies and poorly with stocks. My recommendation is not to invest in manipulated predatory markets.

Tue, 09/09/2014 - 16:52 | 5199223 pendragon
pendragon's picture

bring back peter, the credirt dude rather than this inconsequential bollocks

Tue, 09/09/2014 - 16:52 | 5199224 pendragon
pendragon's picture

bring back peter, the credirt dude rather than this inconsequential bollocks

Tue, 09/09/2014 - 16:56 | 5199235 Bell's 2 hearted
Bell's 2 hearted's picture

Looking forward to Lance "all-in equity" Roberts getting his azz handed to him

Tue, 09/09/2014 - 17:00 | 5199249 NDXTrader
NDXTrader's picture

Greed has done pretty well for the last 5-6 years. Fear should do well over the next. The best thing you could probably do is turn off your TV, don't frequent market websites and just look at what price tells you. If you are long the market simply set a stop no lower than the 200 day MA. It hits that you get out

Tue, 09/09/2014 - 17:28 | 5199338 Peter Pan
Peter Pan's picture

My late mother used to say that if you are not speeding, most accidents can be avoided. By the same token, if you are not leveraged you can ride out most storms.

Leverage is largely a function of greed.

Tue, 09/09/2014 - 17:54 | 5199418 CheapBastard
CheapBastard's picture

The problem is not whether or not you are leveraged; the issue is whether or not you will be bailed out if you are leveraged 64:1 by Hank, Barry, Barney, Piglosi and so on. If it's all "Fedrally Gauranteed" with OPM, then leverage on McDuff ... is their attitude.

 

No accountability should be on that Deadly Sin list.

Tue, 09/09/2014 - 17:03 | 5199260 negative rates
negative rates's picture

The gourmet cook is also committing gluttony in a form he does not relize, a future pain in the neck which had he had more time, might not have hurt so bad.

Tue, 09/09/2014 - 17:03 | 5199261 Bangalore Equit...
Bangalore Equity Trader's picture

Listen. There's nothing wrong with a little psychology lesson. Now you guys "CAN" trade like a pro!

Tue, 09/09/2014 - 17:04 | 5199264 Winston Churchill
Winston Churchill's picture

"A long term investment, is a short term one gone wrong".

"The secret to my success is, I always sold too soon".

Rockerfella.

Tue, 09/09/2014 - 17:04 | 5199268 p00k1e
p00k1e's picture

What about – ‘Even when you are correct about an entity, say GM or Detroit, you can still get skewered on the other end by a Black Swan bailout.’

Tue, 09/09/2014 - 17:15 | 5199295 Jack Sheet
Jack Sheet's picture

"investing" - a truly ludicrous concept in "markets" rigged by central wankers and algobots.

Tue, 09/09/2014 - 17:25 | 5199324 Peter Pan
Peter Pan's picture

The day is fast arriving where the old adage " neither a lender nor a borrower be" may well return to haunt both the borrower and the lender simultaneously.

Should interest rates suddenly go, the borrower will find it hard to finance his debt and the lender may find a large portion of lenders failing and asset values plunging.

Tue, 09/09/2014 - 17:45 | 5199390 ebworthen
ebworthen's picture

Agreed.  Unfortunately, the sheeple will lose their home and car, while the banks (lenders) will be bailed out.

I see no point in saving or investing until that changes.

Tue, 09/09/2014 - 17:47 | 5199386 Lea
Lea's picture

"Greed – greed causes more investors to lose more money than at the point of a gun. 

The human emotion of "greed" leads to "confirmation bias" where individuals become blinded to contrary evidence leading them to "overstay their welcome."

Pride – when things are going good don’t be prideful – pride leads to the fall. You are NOT smarter than the market, and it will "eat you alive" as soon as you think you are."

 


Tell that to the Fed and to the stupendous amount of corporations lobbies that enliven the world so much for us all. 

Tue, 09/09/2014 - 18:03 | 5199454 Kirk2NCC1701
Kirk2NCC1701's picture

1. Why are PMs not on the Periodic Table**?  If they were, I'm sure they'd be on top almost every year. [Q: serious or sarcastic?]

2. The Psychology Cycle holds 100% true for Perma-Bulls, Perma-Bears and Perma-Doomsdayers.  Each set caters to their Base -- to earn a nice lifestyle from said Base.  For most people, Investment closely tracks with Religion, as both have very strong elements of "Faith" (Belief that "their day" will come).

A true pro leaves Faith, Hope and Emotions at the door, and sticks to Objective things: Facts, Logic and Math.  Which is a challenge for at least 90% of any population -- even for an "educated" population, who are far less rational than they think they are.  Were it not so, the 2% would not be running the 98%. 

 

** Tyler or Lance Roberts, please add PM to the Callan Periodic Table (make a ZH Periodic Table) for Reference.  Thanks!

Tue, 09/09/2014 - 18:26 | 5199551 besnook
besnook's picture

the market has essentially taken the emotion out of the market for the average day trader and investor. by getting rid of the human trader for the "guaranteed" profit of the bot trader the human trader simply needs to follow the bot unemotional markers for turnarounds and upturns and downturns and spikes and all the other sub categories of charts that could and did get disrupted by a human disrupter. bots move in lockstep in the same essential pattern day after day, now, year after year, as an autonomous investment class that just responds to the piles and piles of excess money generated by the .1%ers.

Tue, 09/09/2014 - 18:30 | 5199558 antidisestablis...
antidisestablishmentarianismishness's picture

Of course this advice doesn't apply to precious metals. They're special.

Tue, 09/09/2014 - 19:30 | 5199733 Kirk2NCC1701
Kirk2NCC1701's picture

DIVERSIFY OR DIE!  Here is my (time-varying) Asset Allocation Merit Function...

TOTAL WEALTH ALLOCATION per Investment Manager.  Ideally you have enough Cash to invest with several Invesment Professionals/Mgrs, so you can both mititage Risk with any single investment house or Manager, and to compare and rate their performance over a 3 yr moving Time Window.

      SECTOR                       % Allocation

                                         (5% per sector as Default, tweaked avery 3-6 months)

 1   Precious Metals (bullion)

 2   Cash & Money Market

 3   Aerospace

 4   Automotive

 5   Banking

 6   Commodities

 7   Consumables

 8   Energy

 9   Hi Tech (Med, Large)

10  Industrials (S, M, L)

11  Pharma & Biotech

12  REIT

13  Stategic Metals & Minerals

14  BRICS & Asia (Tigers)

15  Developing Markets

16  Gov. Bonds (offshore)

17  Global Corp. Bonds

18  Global Sm. Cap

19  Global Med. Cap

20  Global Lg. Cap

Note that categories 3-13 could be for companies anywhere in the world, rather than being country-slaved.  It is a truism that people invest in stocks and bonds of their own country.  They pretend that they have rational reasons for doing so, but they are smokescreens for bias, habit and ignorance.  A true investor would diversify Globally, not Domestically.  A BIG part of the reason for National Bias, is that the Advisers in one's own country are biased toward their own country and that they are also paid (directly or  indirectly) by the Investment industry.

If you subscribe to allocating your total wealth into Thirds, then you put a Third each into Primary, Secondary and Tertiary wealth.  The above categories are mostly Tertiary (paper) wealth, with PM bullion representing Primary/Natural Wealth.

Just so we're all "On the same page", I define...

Primary Wealth as Real Estate, PM & Jewels, Mining, Minerals and Water ownership or rights, farmland, forest, etc.  IOW: It is Natural wealth (from Nature) that is both a "Store of Value" (against Inflation) and generates Income. 

I define Secondary wealth as owning a Business/Enterprise (that generates Income), or Man-made things of value (expensive Art and Collectables) that act as "Stores of value".  Household goods and Vehicles (cars, trucks, RVs, boats and planes) are Depreciating Assets that cost money to own and operate.

I define Paper/Tertiary wealth as an Income generator (pays Dividends), or an Appreciating Asset whose Net Market Value gains exceed real Inflation.  If it fails to provide and ROI, you hope to sell it w/o incurring additional losses as an NPV (Net Present Value) Opportunity.

One thing I see people overlook or discount constantly are things that are Speculative Investments, but are sold and bought as something more than that.  When people speculate, they are entering an Investment Casino:  They are buying a Hand at the Card Table, they Hope and they try to use their skills and wits.  They often like to pretend that it isn't so, but it is.  "Caveat Emptor.  Aleo Cave."

Tue, 09/09/2014 - 20:53 | 5200117 Zeta Reticuli
Zeta Reticuli's picture

W.C. Fields made a movie called "You Can't Cheat An Honest Man".

Con artists appeal to our Inner Shyster.

Tue, 09/09/2014 - 22:20 | 5200465 Pascal1967
Pascal1967's picture

BARCLAYS AGG looks like a great way to turn a large fortune into a small fortune.  In the bottom three 13 times !!

Wed, 09/10/2014 - 03:30 | 5200907 Expat
Expat's picture

You forgot:

There is nothing you can do as an individual investor to beat the market or even tie the market short of simple, blind luck.  Don't even try.  And when you think you did "okay", Goldman will blow it all up in your face. Ha Ha Ha!

Wed, 09/10/2014 - 06:36 | 5201027 esum
esum's picture

1st investor MISTAKE........"INVESTING" in today's enviroment

we dont have a capitalistic system where merit is rewarded

we have predatory socialist/communist/fascist government, high taxes, regulation and crony enforcement....

THAT IS NOT AN INVESTMENT ENVIRONMENT......it is a CASINO.......... BETS DOWN.....ROLL THE DICE SUKKA

Thu, 09/11/2014 - 03:33 | 5205355 SystemicSarcasm
SystemicSarcasm's picture

profit from the way down anyone? short selling is stil a thing...
afraid that ticks glutonny and greed for me for sure..

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