Bullet Proof Your wealth
Section I: Psychology of Money
The meaning of money from a psychological perspective is a fascinating area. Who could have imagined that your childhood experiences could influence how you think and feel about money today. Who would have thought that your thoughts and attitudes towards money may have an impact across your lifespan and in each area of your life. If you work for someone else, for instance, it may have an impact in how much (or how little) you ask for in return for what you contribute to your employer. Similarly, if you are in business, it may affect how much (or how little) you charge for your products and services.
This webpage provides articles on the psychology of money, followed by the psychology of investing. The articles in this section consider the psychology of money (including money mindsets, relationships with money and money management). The articles in Section II: Psychology of Investing consider the psychology of investing.
Disclaimer: The ideas expressed on this webpage take a psychological perspective on money, finance and share investing. These ideas should therefore not be construed as financial advice. Instead, the ideas expressed on this page provide food for thought on how your own psychology may have an impact on your wealth (short-term, medium-term and long-term). You would be well-served to see a shrewd accountant if you would like financial advice pertaining to your own circumstances. You can book an appointment with Dr. Abramson, if you would like advice managing your own psychology with money or investing.
More to Investing than Just Money
There is more to investing than just growing your wealth. If it was as simple as that, we would all do our research, find a good investment at a suitable rate of growth, deposit our funds and watch them grow.
But, what else is there? And the answer is our very human psyche. Money has come to mean a lot of things to a lot of people. At the very core, money is simply a standardized unit of exchange. But, over the centuries that it has been in use, money has come to mean much more than that. What is more interesting is that we absorb attitudes to money from our parents as we grow up. We may have heard our parents say something like money does not grow on trees or money is the root of all evil. Perhaps we have heard money is just an idea or we can always make more money. Sometimes it is not that these statements are verbalised, but they are such ingrained beliefs that they are acted upon without question. And, as children growing up in our respective families, we absorb those same ingrained beliefs and act upon them ourselves, equally without question.
They say that when the going gets tough, the tough go shopping. Many of us have jokingly described shopping as retail therapy. Yet, the label may be more apt than we realise.
We often use shopping as a means of making ourselves feel good. Yet, how many garments do we have hanging in our wardrobes? Garments that we may have never worn? How many shoes? How many gadgets have we purchased? Maybe we still have gadgets stored in their original packaging. Perhaps we have had them tucked away in the garage, laundry or shed.
Many of us are aware of how we might use food to soothe ourselves if we are feeling lonely, bored, frustrated, anxious or depressed. We may also be using shopping as another means of self-soothing. And, if this is the case, then shopping may indeed be a form of retail therapy.
We may also use retail therapy to self-soothe our angst over our own financial situations. And, when we go shopping, we may find that we spend more, and are less concerned about how much items cost, when we pay by card than when we pay by cash. In turn, our inattention to our spending patterns in the moment can fuel further angst over our own financial situation down the track.
If you don't like the impact retail therapy is having on you (or your wallet), perhaps it is time to declutter your wardrobe, garage, laundry and shed. You can then explore alternate ways of self-soothing, ways that can enhance your health and better protect your wealth.
Buy Now, Save Later?
Would you like to have a banana or chocolate in two weeks time? How about now? Based on research by Benartzi and Thaler, it would seem that most people prefer to have the banana in two weeks time (with the benefits of health coming to mind) but the chocolate now (for the joy of self-indulgence).
What happens when we translate bananas versus chocolate to money matters: Buying versus saving? If asked to buy or save now, that same research suggests we choose to buy. Perhaps we may even speak to how much our costs are at the moment as a way of noting why we cannot afford to save anything now. In many ways, an inability to save may feel quite real in that we may be spending as much, if not more, than what we currently earn, leaving nothing aside to be saved.
It may come as no surprise to find that the same research shows that when asked about whether we prefer to buy or save in two weeks time, we prefer to save. (We know that saving is good for our financial health).
What is interesting is that when we pay by cash, Benartzi and Thaler tell us we feel the pain of paying for something much more acutely than if we pay by credit card. Similarly, the pain of paying is more keenly felt when we pay at the time of purchase compared to when we pre-pay (e.g., conferences, workshops, airfares, accommodation) or pay later (e.g., monthly credit card debt repayments). The pain of paying is also more acutely felt when we see how much we are consuming.
So, if you want to better control your spending: You can pay in cash at the time of your purchase and pay attention to how much you consume. If you want to enjoy your purchases more, you can pre- or post- pay for your purchases by credit card.
And, how might we start saving? Or saving more? Irrespective of whether you currently spend more, all or less than your current earnings, it can be useful to examine each of your typical expenses with a viewing to seeing what can be dropped. For remaining expenses, you might continue by examining whether there are more economical ways of obtaining that same product or service. This may leave you with some (or more) discretionary funds for your current level of income. And, if so, feel free to divide your discretionary funds between pleasure and savings. The actual ratio between pleasure and saving is yours to decide.
By keeping your expenses tight, you will find that you will have a progressively larger pool of discretionary funds as your earnings grow. If you keep to the same ratio of discretionary spending and saving, you will find that you can increase the dollar-amount of how much you regularly save over time. It also helps to know what you are saving for. And, the reason for saving may represent future spending capabilities in the form of investing (own home, investment property, shares, other income-generating assets), rainy day funds, travel and the like.
Money as an Idea
As mentioned in the first article above, money can be viewed in many ways (including as the root of all evil or as an idea). Attitudes to money is more nuanced than these two views with each perspective on money having an impact on current lifestyle and long-term wealth.
The view of money as an idea can open you up to new possibilities and new ways of growing financially. With just an idea, you can always obtain more money short-, medium- and long-term. But, what sort of ideas will generate the money?
Ideas that are valued by others. Ideas can be as simple as a lemonade stand or as complex as a 12-month program. Whatever your valued idea turns out to be, take the time to operationalise it (strategy), share it with the world (marketing) at a mutually agreeable rate (finance) and deliver it to the highest standards possible (resourcing).
So, if you find yourself complaining that you do not earn enough, or that there is never enough money left over from each payday after all the bills have been paid, why not find that valued idea that you can deliver and do what is necessary to make it happen. Click Bullet Proof Your Business if you would like to explore this topic further.
Who we are today reflects the choices we made yesterday. Who we will be tomorrow reflects the choices we make today. This is true across our lifespans and in each area of our lives.
The choices we make reflect the mindsets we hold - our frame of reference based on a selection of attitudes we hold in a particular area. In terms of money mindsets, we can hold the view that there is an abundance or paucity of money. We can hold the view that we attract money or that it slips through our fingers. We can hold the view that money is inherently good and reflects our contributions. Or, we can hold the view that money is inherently evil and that because of it, people will act inethically with greed and self-interest.
Attitudes to Money
Our individual attitudes towards money can be formed early in life. Our attitudes can be so deeply ingrained that we may not even be aware we hold them. Until they are challenged in some way. Even then, we may be more aware of our emotions than we are of the attitudes that triggered those same emotions.
Our attitudes and beliefs around money inform our overall money mindset; the type of relationship we have with money. If we hold positive and empowering attitudes and beliefs, then we will handle our money well. However, if we hold limiting attitudes and beliefs, we will find ourselves financially struggling.
Some people regard money as a form of security. They may budget and look at ways of doing things frugally. This group of people may get anxious or worry over how they will pay their domestic running costs as well as whether they will have enough money to fund their wise years. Other people regard money as a means of garnering respect, prestige or power. They may even buy products to enhance their sense of prestige. It may come as no surprise that high income earners regard money as a good thing while those who earn a modest salary are more likely to regard money as the root of all evil.
Our attitudes to money may influence the kind of financial goals we set. If we hold a money mindset that money does not grow on trees for instance, we may set financial goals that reflect a position of financial struggle; goals that enable us to keep our heads above water. Just. By contrast, if we hold a mindset that money is an idea and merely reflects all the good that we contribute to the world, or hold an attitude of abundance around money, then we may set goals that reflect a position of financial abundance.
When you have strong, conflicting emotions surrounding your attitude to money, you may find that you are unconsciously sabotaging your financial position. It thus becomes important to understand your own underlying attitudes and mindset around money and, if necessary, transform them into more positive, empowering money attitudes and money beliefs.
Knowing Your Money Attitudes
Money is neither good nor bad. However, how we think about money has a powerful impact on how we treat it as well as how we interact with money. Our attitudes and mindsets regarding money lend themselves to our own unique form of money karma. Money can either fall into our laps, or slip through our fingers. As Henry Ford once said: If you think you can, or you think you can't, you're right!
I therefore invite you to consider your own money attitudes. Here are some questions for self reflection to get you started:
- What are your money goals? Do they reflect a sense of struggle (such as wanting to better manage your credit card or more easily meet monthly repayments)? Do they reflect a sense of security (such as growing income by 10% so that you can afford an extravagant holiday) or financial abundance (where income from multiple sources are referred to in the millions)?
- What comes to mind when you think about money, wealth, finance, investing or currency?
- What comes to mind when you think about taxation or insurance?
- What did you see growing up in your family home? What stories did you hear from each of your parents? And from your extended family?
- Keep a journal of your day-to-day activities for a week. What financial activities frustrated you over the week? And, what brought you joy?
Enjoy your discoveries around money and what those discoveries can do for you!
On Unhelpful Fears and Beliefs
Once upon a time, I could not swim. And behind this inability lay a healthy fear of the water. Yet, it was something I wanted to be able to do for a very long time. Naturally, I made sure my children could swim. And, they can. But, I remained unable to swim. Sometime ago, I joined a gym that has an aqua program (water aerobics and swim classes). Needless to say, with that healthy fear of the water, I decided to do the water aerobics classes. You could stand up in the shallow end of the pool throughout the classes. So, I was fine. My gym also has a 'cool' heated pool. So, after the water aerobics classes, I would wander in and splash about a bit. No-one there could swim so I was in good company.
After having attended the aqua classes for a while, I renewed my vow to learn how to swim. I did not know how I was going to accomplish this at the time, given that I still had a healthy fear of the water. However, I somehow found a way. I am now comfortable in the water, can float and swim-a-bit. My swimming skills are a work-in-progress.
Why have I shared my journey thus far? Swimming is a highly-learnable skill. Based on my own experience, you do not even need a teacher. You can learn from books, DVDs and watching what others do in the water. (Kinda like the way toddlers learn to walk). The only thing stopping me from learning was my healthy fear of the water. Something that was initially triggered in me by the way swimming was taught when I was a child. (Thank goodness, swimming instruction has come a very long way since).
There are many things in life which are equally learnable, yet there is a deeply ingrained fear or belief that is holding us back. Our own 'fear of the water' problem. Sometimes, we can live a healthy, happy and prosperous life outside the scope of that limiting belief or fear (as was the case with my inability to swim). Yet, what world will open up for us if we can address those fears or limiting beliefs? I therefore invite you to think about any limiting self-beliefs or fears you might have around money and whether or not those fears/beliefs might be holding you back. I also invite you to consider what you can do to overcome those fears and limiting beliefs so that you, too, can swim your way forward to a healthier, happier and more prosperous you.
Overcoming Limiting Self-Beliefs Around $$$s
How might you replace a limiting self-belief around money with something more helpful and constructive? This article provides a four-step process to overcoming limiting self-beliefs around money.
The first step in overcoming a limiting self-belief around money is to identify and recognise the belief for what it is --- nothing more than a limit on your own potential around money matters. Your reflections on the above articles may provide clues as to any limiting self-beliefs you might hold around money. You may also recognise the presence of a limiting self-belief when you hear yourself speak out of frustration or disappointment over something that just happened.
The second step in overcoming a limiting self-belief over money matters is to consider what belief might be more helpful to hold instead of the currently limiting one. You get to consciously choose what's more useful, constructive and empowering for you. So feel free to reflect upon this issue until the right belief emerges for you.
The third step in overcoming a limiting self-belief is to find evidence in support of the new, more empowering belief. If, for instance, you held the view that money is the root of all evil, you could say: Money is neither good nor bad. It is what you choose to do with it that counts. You could then look for the examples that show how money has been used for the good of others.
The final step involves putting your new belief into action. At first, it may feel strange. It would be nice to really believe this belief, but somehow you may not yet be so sure. It becomes important to be curious over the results you will get from the vantage point of this new belief. As you operate from the vantage point of the new, empowering belief, you will find you acquire increasingly more evidence in support of your new belief. In the early stages, you are learning what it is like to try on the new belief and to live your life from the vantage point of this new-found belief. As you develop your skills and abilities through the lens of this new belief, your confidence and skills will continue to grow. Before you know it, it will feel as if you have always held this belief. And when that happens, you can truly enjoy the benefits of your newfound belief.
Money, Self-Sabotage and ReWriting Your Money Future
Do you have financial goals and aspirations that never seem to be met. Perhaps you find yourself setting the same financial goals that you did in previous years. Perhaps you find yourself in the same financial position (and rut) that you were in twelve months ago. If this sounds like you, you may be acting in a way that keeps you in a money-rut. So, what can you do?
It may be a good time to reflect upon the ideas, beliefs and attitudes you hold around money. To the extent that you understand the attitudes and beliefs you hold around money, you have taken the first steps towards rewriting your money future.
The second step is to challenge old attitudes and beliefs around money. It is not necessarily the case that money is always used for selfish reasons, for instance, there are occasions where money has been used for very noble purposes. If you have it in your head that it is impolite to ask for the money after delivering a product or service ask yourself who says?. Chances are, it was someone who did not want to pay for a product or service they had already benefited from.
The third step is to obtain any necessary financial education you might need and doing your financial homework. This may mean simply preparing a budget for the next twelve months, based on your previous financial activities. As part of this process, you may decide to tweak your budget so that your expenditure is as tight as it can be and reflects no more than 90% of your annual income. It may mean attending a course on how to budget or learning how to use financial software. It may also mean making an appointment with a shrewd accountant to discuss your financial position.
The final step involves the preparation, and operationalisation of, your own financial plan; one that aligns with your financial goals. It is useful to use a twelve-month time-frame here. You can then review your plan, along with how well you performed over a twelve month period before preparing your plan for the next twelve months. Each time you review your old plan and prepare the next one, you can take the opportunity to revisit any limiting beliefs that may percolate to the surface.
By taking this four-step process, you will find that you are taking a learning approach to financial management. And, by learning from the results you get, you will find that you can ultimately move towards your long-term financial goals.
For many of us, establishing more helpful, empowering beliefs around money may be enough to live a richer and fuller life. Other people may find that a significant event or long-forgotten issue triggers the old unhelpful, disempowering attitudes and beliefs around money.
If this happens to you, you could reflect upon what that significant event or long-forgotten issue is telling you. You could consider how you feel about it as well as what might be more helpful to feel. You could also recognise that the significant event or long-forgotten issue is what it is. This would then free you up to consider how you could reinstate your more empowering attitudes and beliefs around money and what you might need to do to ensure it remains in place going forward.
At the end of the day, you can fully enjoy the benefits of employing empowering attitudes and beliefs around money.
Quick Money Tip
Have you ever said to yourself I am never gonna ... or who am I to ... or I am not interested in the money, just the product/service I am delivering ...? This kind of negative self-talk limits how far you can strive in general as well as financially. It is far more effective to say something more empowering to yourself. So, when you catch yourself saying something that could limit the results you get, why not stop yourself and challenge the negative statement. You may like to reflect on a more empowering statement you can say to yourself. And, when you find one that sits well with you, look for the evidence that supports your new statement.
Useful Money Mindsets for Entrepreneurs
From the above articles, we know that our attitudes to money can influence the financial results we get. It may not be a surprise to know that we will accomplish more through our businesses, if we hold useful and empowering mindsets and attitudes around money, than if we hold limiting ones.
As an entrepreneur or business owner, it may be more useful to take an abundance view of the world (ideas, money, wealth, and customers). It may also be useful to view money as an idea itself - one that comes to the business owner in return for the value of business' offerings. Finally, it may be useful to monitor your own attitudes and mindset towards money in the business. Your attitudes and mindsets may come out in both the good times and the bad. If you find that there is something holding you back or holding you down financially, such as a belief that money just slips through your fingers, you may like to reflect on how you can better hold onto your income. You can then restate that belief into something more constructive for you.
At the end of the business day, you can develop constructive money mindsets and attitudes and watch your business thrive.
Developing an Abundance Mindset
A mindset of abundance may seem to be relevant just to business owners. But is it? When you take an attitude that there is abundance, rather than scarcity, you act differently in each area of your life. This article shares nine tips to developing an abundance mindset.
Tip 1. Sense of Purpose: When you operate from a sense of purpose, you forget yourself in the mix. You also forget things like scarcity and what if I can't scenarios. Instead, you focus on what it is you want to accomplish.
Tip 2. Think Big: While you are at it, make sure you think big when you identify your sense of purpose. Once you have done that, think bigger still, and bigger again. The world is truly your oyster and is limited only by the limits to your imagination.
Tip 3. Focus on Opportunities: When you take an opportunity-focus, you create something from nothing. You get to create your own abundance. You can take an opportunity-focus at home, at work and in your investments. Once again, the world is your oyster, only you get to decide which oyster you tap into.
Tip 4. Look for Win/Win Scenarios: As you determine your sense of purpose, be sure to couch it in a way that leads to win/win scenarios. Be generous with your heart, time and money. Look for ways of helping others on their respective journeys. What you give out will come back to you in delightfully intriguing ways.
Tip 5. Mix With those Who Hold an Abundance Mindset: Surround yourself with others who hold an abundance mindset. Spend as much time as you can with them, discussing matters across a wide range of topics. It does not matter what you discuss with them, what matters is just how much you pick up by hearing how they think.
Tip 6. Be Empowered: Have a full body stretch where you reach for the ceiling. Stand, sit and walk tall throughout your day. See also the article entitled Quick Tips: Building Confidence under Bullet Proof Your Brain.
Tip 7. Be Curious: Allow yourself to be curious, take a learning-focus in everything you do and just experiment to see what works. This takes a lot of pressure off yourself and circumvents problems of perfectionism, time management and any other self-set standards that may might get in your way.
Tip 8. Take a Can Do Attitude: Consider how you can make something happen rather than whether or not you can actually make it happen. In some instances, you may need to hire people to assist you, attend specific courses or make certain financial investments. You may find it helpful to use more definite languaging such as when rather than if when you are thinking or speaking to what you would like to have happen.
Tip 9. Be Proactive: Do not wait for the perfect timing before taking action. When you know what you want, just go for it. If you have your heart and mind set on something big, do a small piece of it everyday. If it is something you can work towards quickly, set aside some time in your diary so that you can attend to it.
Healthy, Helpful Money Habits
They say that the best time to plant a shade tree is 20 years ago. The next best time to plant that tree is today. In order to enjoy the fruits of your financial labour, you need to prepare the groundwork today. By introducing the right financial habits into your life, you will find it easier to reach your financial goals. Here are some healthy, helpful financial habits to think about:
- Reflect on your current financial position and financial goals. What you are doing that is helping you reach your financial goals? What might be hindering progress to your financial goals? What knowledge, skill or abilities can you develop to bypass blocks to your financial goals? The answers you come up with here can help inform a financial course that you can proactively plot for yourself.
- At least once a week, gather your loose change and deposit them into a savings account. While you are at it, you can consider what costs you can trim or accomplish more economically. You will then have even more to deposit into your savings account. As you are building up a healthy bank balance, you can be googling potential investments (including shares or property) so that you are ready to invest once sufficient funds permit.
- Whenever you are driving, taking public transport or waiting in queues, you can take the opportunity to listen to, read or re-read educative books or audios on accounting, finance, financial management or investment.
So, what is your money karma? And what can you do to develop your money karma in a healthy, helpful way?
Money and Life Partners
What happens when two people decide to live their lives together. And, one is a great spender while the other is a great saver? Perhaps they live in a single-income household where one is the official breadwinner while the other keeps the family home. More often than not, it is the one who works full-time that is more financially conscious than the one who stays at home.
This can set up uncomfortable dynamics within the life partnership. The one who works is cast into the role of being mean and tight-fisted while the one who stays at home is cast into the role of being irresponsible. It is natural to be more conscious about your hard-earned dollars if you are the one generating the income. It is also natural to be more focused on the products and services you buy when you are the one who stays at home.
This dynamic may also play out in dual-income households, irrespective of whether one member of the life partnership earns significantly more than the other. So what else might be going on? They say that opposites attract. While such differences might be cute when dating, it can become frustrating after years of living together. Underlying it all, may be a difference in financial goals, goals that have not been discussed and are therefore not shared. To the extent that you might sit down with your life partner and start discussing financial goals, you can begin working towards common financial goals. Then, you may discover that your life partner becomes more accommodating or responsible while you both strive towards your shared financial goals.
Money and the Passive-Aggressive Partner
What happens when you have a passive-aggressive partner? And, your partner controls the finances? You may find that joint bills in your name are forgotten while those in your partner's name are paid promptly. Perhaps the bills in your name are only forgotten when they are angry with you for something specific, but are not willing to openly discuss that particular matter with you. Either way, the passive-aggressive partner can damage your credit history while keeping their own intact. So what can you do?
You could begin by picking up a good book on budgetting or attend a short course on managing one's personal finances. From there, you can discuss taking on a more collaborative approach with your partner. Your partner may remain passive-aggressive in other ways. However, with your active involvement, bills in your names will be paid just as promptly as those in the name of your partner.
Money and Retirement
The dynamic discussed in the previous two articles may also play out in the retirement years. You may think that you both have shared lifestyle and financial goals. And, yet, there may be something that you do, or your life partner does, to indicate otherwise. If you see signs that goals and aspirations you both thought were shared are somehow being blocked, it may be time to sit down with your life partner and talk it out. Behind the blockage may be some value, belief or difference of opinion about how your retirement years should be lived. By identifying those differing values, beliefs and opinions, you can then find a shared position you can both be comfortable with. From there you can both set common financial and lifestyle goals that are genuinely shared and that can take you through the wisest stages of your life partnership.
Retirees who live alone may need to give themselves permission to fully enjoy their lives, be it travel, physical activities, intellectual stimulation, hobbies and interests or contributions to the next generation. Living alone means not having to collaborate with anyone else on how you live your life. However, it can mean balancing your own wishes with those of your children and grandchildren (and perhaps even great-grandchildren) It is therefore worth your while to take stock of what you enjoy doing and what you can do, given your financial position. At the end of the day, you want to go to bed with a smile on your face. Each and every day.
Section II: Psychology of Investing
This section provides articles on the psychology of investing (including investor psychology, fight/flight behaviour and using investor psychology to hone your own investment strategy).
What is Behavioural Finance?
Behavioural finance, (also known as economic psychology), is the study of the very human-side of investor behaviour - including how share investors may act irrationally in the share market.
The articles below consider the very human-side of share investors and is based on Dr. Abramson's doctoral research.
Invest for the Lifestyle
When we invest for ourselves, we are ultimately investing as a means of maintaining our current lifestyle throughout our wise years. While we are working, we are in an ideal position to build wealth for our wise years. Yet, more often than not, we find our expenses expand to fill the income available. And, then some. So, what can we do to build wealth for our wise years?
It is useful to begin by articulating your lifestyle goals and objectives for your wise years. If you have a life partner, this is a task best discussed with your partner. You may also want to visit your current lifestyle and note what is important (and that you want to maintain), and what is not so important (that can be dropped). Once decided, keep your lifestyle goals at the forefront of your mind with each investment decision you make. You also need to keep your lifestyle goals at the forefront of your mind through share market gyrations.
From there, it simply a matter of obtaining the necessary knowledge and expertise. Some of this knowledge may come to you as you research potential investments. The balance may be obtained through the services of a shrewd accountant.
At the end of the day, we can plan our investments with our lifestyle goals and objectives in mind. And, we can ultimately enjoy the investment results we get.
How to Know if You Have a Profitable Investment
Have you ever invested in shares in a particular company and watched the share price fall after you invested? Ouch! Have you held on for years afterwards in the hope that the share price will recover? And, you are still waiting?
Perhaps you are so disappointed with your early investment choices that you have yet to make any further share investments. Good money after bad? If so, you may regard investing as just another form of gambling, but is it?
You may have seen something that the rest of the share market has yet to see. If so, you have taken a big risk that may take many years to bear fruit. The risk that you have taken may be much greater than you realise. If so, you may have placed more capital in the share investment than you are actually prepared to lose. It is only natural to feel frustration and disappointment when you see the share price continually fall from your initial purchase price.
Perhaps you have recognised a great new investment opportunity that other share investors have also recognised, but acted once everyone else has already invested in the asset and are now seeking to capitalise their gains.
Perhaps you are the only one to recognise this investment opportunity but there are factors you had not considered (both internal to the company and external). If so, it may be a factor of where you source your information, and the range of information sources you utilise.
Yet, it is possible to make share investments that consistently grow over time, giving you ongoing dividend income and/or capital growth from your investments. The secret is all psychology: Yours and those of groups of investor who operate on masse with one another (such as mum-and-dad investors or institutional investors).
Trading and Investing - Are they Forms of Gambling?
Are trading and investing forms of gambling? Trading and investing are different activities with different time horizons. Traders may buy shares that are rising in value with the intent on selling them for a capital gain over a short period of time (such as 24 or 48 hours). However, you have to time it so that you get out before the direction of trading changes. This can be a gamble.
Investing involves researching shares of a particular company to identify whether or not they are worthwhile to buy with a view to holding 3-5 years, perhaps indefinitely. As an investor, you may consider what the company behind the shares does and how they do what they do. If you like the what/how, you may then consider the pricing of its shares. The underlying value of a company's shares may differ from how much you can buy/sell them for. When you know how much a company's shares are genuinely worth, you have taken much of the 'gamble' out of the investing equation. The better you are at valuing shares, the better you will be at buying shares at a fair, or discounted, price. And, when you buy well, you can ultimately sell well.
Bubbles and Crashes
There have been times in the history of the share market where share prices have risen higher or fallen lower than was called for (eg., Tulip Bubble, Internet Bubble and The Great Depression). In each case, investors recognised a great new investment opportunity. They all wanted to ride the wave up (and enjoy nice, healthy capital gains). But it gets to a point where there are no new buyers to buy from you and existing investors are ready to capitalise their gains. When that happens, the price of that great new investment opportunity starts to reverse and then fall to pre-bubble prices. In the case of The Great Depression, the whole market collapsed. Even shares in valuable companies became highly discounted to what they were really worth. Shares in speculative companies became worthless.
Why does this continue to happen over time? Perhaps because investors and traders 'there' for one bubble (and its subsequent collapse), were financially burnt, so much so that they have no interest in the next one. In some cases, they were no longer alive to warn their children or grandchildren about their experiences. Each generation of investors are left to learn this lesson for themselves - unless they obtain some sound financial training provided by independent professionals.
Benjamin Graham was one of the first to recognise the volatility we see in share markets. He coined the term Mr. Market to personify share market behavior. [Graham's book was initially published in 1949 - a time when most investors were men. The salutation of Mr. was thus very apt for the times]. Graham recognised that Mr. Market may act rationally for most of the time, but that there would be periods where Mr. Market would become euphoric and seek to invest in shares, no matter what the price. Graham also recognised that there would be other times when Mr. Market would become despondent or fearful and would try to sell out of his holdings, no matter how little he might get for his holdings. Graham advised investors to ignore the gyrations of the share market and only approach Mr. Market when we want to buy or sell shares. He also advised investors to buy when Mr. Market is keen to sell and sell when Mr. Market is keen to buy. In so doing, we can buy well to sell well. Warren Buffett has used a variant on Graham's approach, with consistently remarkable results.
The personification of Mr. Market begs the question of what might be going on behind the extremes of euphoria and fear within Mr. Market's behavior. Investor overconfidence may be one of the characteristics of Mr. Market. The next few articles consider other characteristics that may contribute to Mr. Market's behaviour.
Share investors can sit somewhere on a continuum of confidence; with one end of the continuum representing a lack confidence (i.e., underconfidence) while the other end of the continuum representing overconfidence. The middle of the same continuum represents a healthy level of confidence. Underconfident investors may invest in blue chip investments with the intention of holding them for the long-term. Overconfident investors may make more risky investment decisions and turn over their share investments more quickly. Past research has shown that overconfident investors do trade more and that those trades have a deleterious effect on portfolio wealth. That same past research has also found that men trade more than women and that the difference in overconfidence is even more pronounced for single men than it is for married men.
When you look at the share market as a whole, you can see that there are times when shares in certain companies are avoided i.e., losers while shares in other companies are highly sought-after, i.e., winners. What is interesting is that academic research has consistently shown losers outperform winners for up to five years. Investors acting in tandem appear to overreact. It seems the Grahamian concept of buying when Mr. Market is fearful and selling when Mr. Market is euphoric has its wisdom.
What is also interesting is that individual and institutional investors can seem to be acting in tandem with one another to the point that there is an upward pull on share prices at times of euphoria and a downward push on share prices at times of fear. To outside observers (and indeed, the academic world), it can seem as if investors are acting irrationally. I prefer the term human.
Appetite for Financial Risk
Just as our position along a continuum of confidence can vary, so too, can our position along a continuum of risk appetite. The greater the appetite for financial risk, the riskier the share investments we are prepared to invest in. The lower our appetite for financial risk, the more we are inclined to make conservative share investments.
Irrespective of where we sit along the continuum of risk appetite, it would appear that we are more inclined to acept the risk while share prices are increasing (and congratulate ourselves for excellent share selection). However, we are not prepared to accept the same degree of risk when share prices are falling. We often find ourselves dramatically changing our share selection at such times or pulling out of the share market all together.
This is why it becomes very important to understand the true degree of risk we are taking on in our share investments. It may mean making more conservative decisions than we might think we want in good economic times so that we are comfortable riding out the poor economic times. Confidently.
Information and Social Herding
How does it happen that investors overreact? How do they get to overreact in tandem with other investors? The academic literature refer to social herding, where investors have a tendency to follow the crowd. There may be a sense of safety in being where everyone else is, when they are. There is research to suggest that social herding even occurs with stock brokers, where they all follow one another in the recommendations that they make.
But, there is more. Decisions are made on information. And, investors get their information from the same sources: The media (e.g., print, radio, T.V.). If you are accessing the same media at the same time as fellow investors, you will be reaching similar decisions, and taking similar steps, at the same time as your fellow investors. When that happens, the market as a whole will appear to be operating as one big social herd.
So, what does this mean for us as investors? Perhaps use other means of keeping yourself informed about your investments. If you are accessing the same media as fellow investors, consider how other investors might respond to this information before deciding what steps to take on your own investments.
The January and July Effects
The January Effect is a phenomenon where share prices dip over the last few days in December of a calendar year and bounce back in the early days of January. The January Effect was first observed in the U.S. where the financial year aligns with the calendar year but it has been observed in other countries, not just those where the tax year aligns with the calendar year. In Australia, there is both a January and July effect. The January Effect has been attributed to tax-loss selling and portfolio rebalancing. It has also been attributed to a pooling of funds from share sales with those from other sources (including holiday bonuses) before making any fresh purchases in the new year.
Is the January Effect Another Herd?
Just as investors may appear to overreact after they have accessed the same news at the same time as fellow investors, investors may also be acting in tandem when they clean up their portfolios or engage in tax loss selling at the end of financial or calendar year. (First social herd). They may then await the proceeds from those sales before reinvesting their cash proceeds in the new calendar and/or financial year. (Second social herd).
When investors sell the same shares as a herd (because of the desire to clean up portfolios or take advantage of tax loss selling), it creates a downward pressure on share prices. Similarly, when investors buy the same shares at the same time, it creates an upward pull on share prices. So, what can we do as investors?
The simple answer is: Do not wait! If you know you want to clean up your portfolio or capitalise a loss for taxation purposes, do so as soon as you reach your decision. Do not wait until the end of the calendar and/or financial year to do so. When you do so immediately, you separate your activities from those of other investors who do not act until the end of calendar/financial years. You then free up your cash (from the sale proceeds) at different times to fellow investors, leaving you free to make your investments purchases at a time of your choosing. And, by not waiting, you avoid taking part in either of the two social herds.
It is not just strong emotions (such as fear, anxiety, greed or euphoria) that can influence our behaviour in the share market. Our investment decisions can be influenced by psychological biases. Psychological biases reflect faulty thinking at some level of analysis. Seven of the most common psychological biases are discussed below:
Anchoring: Anchoring is a psychological bias where investors tend to evaluate their investments in terms of a set point, usually the price point at which the investor purchased his/her shares. This might seem like a sensible thing to do. You want to know how your share portfolio is tracking and whether or not your investments are profitable. However, this bias means that investors tend to consider investments from the vantage point of their initial anchor, while downplaying relevant information about the company, industry it operates in and other factors that may inform investment decisions.
Disposition Effect: The Disposition Effect occurs when investors capitalise gains too quickly and hold onto losing stocks too long. In so doing, investors may miss out on more of the potential gains while potentially increasing the extent of capital losses down the track.
Endowment Effect: The Endowment Effect occurs when investors expect the same shares to be sold for more if they already own those shares than they would be prepared to buy those same shares if they did not own the shares. This may mean that investors do not end up buying shares (because they cannot get it cheap enough) while missing out on capital gains (because the shares are not currently attracting a sufficiently high price in the share market).
Familiarity Bias: The Familiarity Bias occurs when we prefer to invest in local companies over national or international ones, perhaps investing in companies for whom we are also a customer. Investors who do so, tend to have a low risk appetite than those who will also include national and international companies in their investment portfolios. Investing in local companies may not seem like a problem per se, however, such investments may lead to poorer investment returns in economic downturns.
Mental Accounting: Mental Accounting is a psychological bias where investors mentally establish separate accounts, with each account serving a different purpose. For instance, one account might be set up for day-to-day needs; another for day-trading; and a third for long-term investing. On the surface, this approach may seem like a good money-management technique. However, the maintenance of several separate accounts may also mean that there is also no fluidity between accounts when needed. Moreover, if an investor purchased several parcels of shares (accounts) within the same company, the investor may expect each parcel of shares (account) to be profitable before being sold for capital gain (as opposed to selling the combined parcels for an overall gain).
Representative Bias: Representative Bias occurs when we treat one thing as a representation of another. Thus, the shares of the company are seen as no different from the publicly-listed company itself. However, the company may demonstrate a different financial performance than that of its share prices.
Status Quo Bias: The status quo bias occurs when investors have a tendency to stay with the status quo. By staying with their current portfolio makeup, investors may amplify potential losses or miss out on more lucrative investment opportunities.
Fight - Flight - Freeze
Our brains have been wired to respond to life-threatening events. If we see a hungry lion hungrily licking its lips while looking at us, we are not going to stop cuddle it or stroke its fur. The moment we sense the presence of that hungry lion we are running. We may even be running for our lives before we consciously realise that it was a lion we saw. If it is a different kind of animal we think we saw, we may choose to prepare ourselves to stay and fight.
This response is typical of fight/flight behaviour. It is triggered by a small area in our mid-brains known as the amygdala. The amygdala is often called our danger detector. The amygdala cannot distinguish between that which might literally kill us (such as a hungry lion) or something that might cause us distress (such as an angry boss or share market decline). The amygdala is able to evoke action before we are consciously aware of what is happening by flooding us with fear and anxiety. The amygdala will simultaneously slow down any digestive processes happening within the body and prepare our major muscle groups for fighting or fleeing. It may be only after we have begun running for our lives (literally or figuratively speaking), that our conscious minds may catch up with us and wonder what we are doing. By that time, we may have already taken action based on the levels of fear or anxiety coursing through our bodies.
It is interesting to note that the amygdala may also cause us to freeze in what it considers to be a life-threatening situation. You may have seen animals roll over and play dead when they are overwhelmed by a situation that could prove deadly for them. Many people seem to freeze when called upon to speak in public. While public speaking is not life-threatening, we may feel as if our whole life depends on how well we perform on the stage. If we find ourselves freezing, we could find ourselves unable to express our thoughts or ideas. Indeed, we may even find ourselves feeling so overwhelmed that words are just not available to us. What we may not be aware of is that our breathing becomes quite shallow when we freeze, so much so that we are not fully oxygenating our bodies.
So, what should we do if we find ourselves flooded with emotions of fear or anxiety? If we find ourselves metaphorically running for our lives, we need to stop and remind ourselves that, chances are, we are not being faced with a hungry lion. We need to give our conscious minds a chance to catch up. And, we can do that by slowing ourselves down. Breathe. Breathe deeply. Ask ourselves (a) what is actually going on; (b) what would we like to have happen; and (c) how might we best have that happen.
If we metaphorically find ourselves freezingat the podium, so much so that we are too nervous to articulate our thoughts or ideas, we need to remind ourselves that our audience is not made up of hungry lions. Once again, we need to slow ourselves down and ensure our whole body is properly oxygenated. We can best do that by breathing deeply (before, during and after the talk). We may also find it helpful to rehearse the talk (imaginally or in vivo) until the talk unfolds the way we want it to. You will also find it helpful to visualise a positive progression and outcome of your talk. Finally, it is often helpful to do a full body stretch, standing as tall as you can before you walk up to the podium. Doing so will give you an added boost of much-needed confidence.
For many of us, these strategies may be all you need to manage the levels of fear and anxiety evoked by our amygdalae. However, if you find these strategies insufficient to help you manage the level of fear and anxiety, perhaps it is time to book an appointment for hypnotherapy with Dr. Abramson.
Fight - Flight - Freeze in the Share Market
When Cannon developed his concept of fight - flight behaviour, he noted that this behaviour can occur in share markets. When investors act in unison to sell their shares in a particular company, they are 'fleeing' in fear of losing their capital.
Part of the reason investors can act in unison in today's share markets may, in turn, reflect the ready access to news (print and social media) in a way that previous generations of investors did not have. If a company has news to release, it can be disseminated to investors quickly and egalitarianally. With investors receiving (and digesting) the news at approximately the same time, they are ready to act at the same time as other investors. If one piece of news led investors to conclude that they should sell their holding in a particular company, that news item creates downward pressure on the share price. And, the more investors wanting to sell their holdings, the greater the downward pressure on that company's share price. Over time, the downward pressure can act to fuel other investors into selling their holding. This trend will continue until there is no-one left wanting to sell their shares in the same company. Then the downward momentum fizzles out and starts to reverse with new buyers hunting up a bargain. In some cases, the news item about the company is significant to the company's business operations (and the subject of that news item may have a detrimental effect on the company's bottom line). On other occasions, the news item is insignificant and the company will continue to do business just as strongly as ever.
So, what should we do as investors when faced with such news about one or other of our investments? Begin by reviewing your own investment strategy and protocol. You will want to keep your investment strategy and protocols at the forefront of your mind. If your strategy needs tweaking, by all means, do so. However, if it is sound, you want to base your decisions within the frame of your investment strategy and protocols.
You can then continue by doing your own independent research on the company (management team and financial position). You will want to assess to what degree the news item is insignificant or likely to have a major (negative) impact on the company's bottom line. With your own analysis to hand, and your own investment strategy at the forefront of your mind, you are then in a position to make a more reasoned/considered decision on this particular company. You may, for instance, go with the direction of the market. Or, you may end up acting contrarially. Each time you utilise these two steps in your investment decision-making, you will find that you are honing your investment skills (for the betterment of your long-term wealth).
Keeping Your Cool
What if you can see a profitable investment opportunity that no-one else yet recognises? You may feel like a fool when fellow investors are running in the opposite direction to the one you think you should take. Perhaps you wonder why no-one else sees what you do. Until they do. Then, you can wipe your brow with relief as the unrealised (or realised) capital gains roll in. How many of us have the fortitude to wait for that opportunity to reap its rewards. Nice if you can put a huge pile of money into that opportunity and later watch an even bigger pile of money rolling in.
As your investment skills grow, you are likely to identify a profitable investment opportunity that no-one else does. You may recognise the opportunity because of your unique set of knowledge and skills (outside the world of finance), knowledge of the industry to which the share investment belongs as well as skills in valuing shares. If/when this happens, you may be in a position to invest in that opportunity; an investment that may run contrary to the actions of other investors. This is where fortitude is required. If you have done your sums right, you may have much to gain by so doing. If wrong, you will have added to your financial education, enabling you to hone future investment decisions. With this in mind, you are well-advised to only invest what you are willing to lose. You will find that you sleep better at nights by so doing.
And for the rest, you can keep your cool by practising the relaxation techniques you enjoy using (such as deep breathing, mindfulness, yoga, meditation or self-hypnosis). Keep your analysis and reasoning at the forefront of your mind. Remind yourself often of why you have taken the steps that you have. And, wait.
Not every investment opportunity you identify will pan out the way you expect. Some may do better than you anticipate. Others worse. Time will tell. But, with each investment opportunity you undertake, you can be guaranteed of learning something new about the investment world. And, you will have invested in your biggest asset: You. So do your research, form your conclusions and invest on the strength of your conclusions. Be prepared to be wrong - there are other investors at play here. Be prepared to wait to be proven right, or wrong. And, learn from each investment (the good, the bad and the ugly). By following your own wisdom, you will ultimately do well.
Useful Mindset for the Share Investor
Academic research asked the question of whether or not share investors were irrational. I prefer to describe investors as very human. But whatever term you use, it is clear that certain investor mindsets are more helpful than others. Here are five factors to take on-board when developing your own mindset around investing:
1. Keep cool: It is important to keep cool, calm and collected when considering your investment decisions. You also need to take a long-term perspective, rather than react to current share market activities. After all, if you wait long enough, the market will turn back on itself and head off in the opposite direction.
2. Do not get too confident in your own abilities: We tend to make the greatest investment mistakes when we think we cannot go wrong. We also tend to trade too much when we are overconfident and that extra trading tends to weaken our investment returns.
3. Get a financial education: Your financial education should include short courses or books on fundamental analysis so that you know how to analyse company accounts. You will hone your education each time you examine potential share investments, make a judgement as to whether the company is a good one, as well as whether the company's shares are available at a fair (or discounted) price.
4. Hone your own investment strategy: From there, you can develop your own investment strategy. Make your share selections based on your own investment strategy. And, as Benjamin Graham suggests, ignore the share market gyrations. You may find that, early on in your investment career, you may make a few poor share selections. As long as you learn from each investment (the good, the bad and the ugly), you will ultimately develop your own sound investment practice.
5. Do not follow the investment crowd: Once you have made your share selections, you should not need to touch them unless and until you have further funds to invest. If you chop and change your investment strategy so as to follow the investment crowd, you may find that you are investing in fad-like investments; investments that may not hold their value over time. Even if the investments do not turn out to be fads, you may find that by the time you have found out about them, you are too late to purchase those investments at a fair price. It takes a lot of internal strength to be able to invest independently of the direction of the investment crowd. You will find this factor much easier to incorporate into your investment mindset once you have mastered the first three factors.
At the end of the day, you can develop and hone your own investment mindset; one that will ultimately serve your portfolio wealth well.
Many Will Offer Opinions
There are many ideas out there that promote one or other different investment strategy or product as the best way to invest. They cannot all be right Yet they are all both right and wrong. Each investment strategy has merit. However, some strategies carry more risk or skill than others. The best thing we can do as investors, then, is to educate ourselves as to the kinds of investment strategies that make sense to us. And, then for the one or two strategies we choose to adopt, obtain further education on those strategies. There may be short courses you can attend to develop your skills in your preferred investment strategy. However, after the courses, you can only learn by doing. So, start small. Perhaps even start on paper (without any capital outlay). Once you are confident in your approach, you can then proceed to investing small sums of money. Once you are confident with your success in small investments, you can progressively proceed to increasingly larger investments.
The best way to select investment products is through your own financial analysis - and the methods you choose to analyse each product will depend on your chosen investment strategy. Each time you make an investment decision, you will be well-advised to stay with your own preferred investment strategy. Do not let the opinions, excitements or fears of others to detract you from your own strategy.
At the end of the day, you can keep refining and honing your own preferred investment strategy. Doing so will place you in the best position to maximise the capital available to you in your wise years.
Who Do You Trust?
Investors may not necessarily have the confidence to manage their own investment portfolio. So, they may turn to financial experts or they may seek out training to guide their strategy. With a range of choices out there, it can be daunting to find the right expert or training facility for you.
Yet, investors who directly manage their own portfolios have a vested interest in how well their portfolio performs over time. We may make a few poor investment decisions early on (hopefully while our portfolios are still small). However, we learn from those mistakes. And each investment decision we make helps hone our investment skills so that by the time our portfolio is of a substantial size, we absolutely know how best to manage our own portfolios.
So, the person one should trust to manage your own investment portfolio is yourself. The next article provides a list of resources that you can comfortably draw upon to get the help you need. I will be adding to the list from time to time.
In the interim, if it sounds too good to be true, it probably is not true. If you are offered an investment opportunity with promises of stratospherically-high investment returns, the person likely to enjoy those stratospherical returns is the one offering the investment (not yourself).
Useful Resources for share investors
- Reading: (1) Books on Warren Buffet; (2) Benjamin Graham's The Intelligent Investor.
- Learning about share investing: Australian Stock Exchange online short courses.
- Discussion of your own financial position, tax implications or investment structures: A shrewd accountant and/or lawyer.
What's New at RACHEL
Dr. Abramson is in the process of preparing a book out of her interests in the psychology of money and investing. As she does, she will share more snippets of information on this page. If you would like to know more, feel free to bookmark this page so that you can come back to it on a regular basis. You can also email Dr. Rachel Abramson to sign up for our newsletter Money Quarters or be informed when this book has been published.
You can also follow Dr. Abramson on Facebook or Twitter.