What does it take to succeed at investing and build wealth, that ultimately gains us financial independence?
I believe, based on my 15 years of investing experience, that for successful investing, psychology matters more than finance and maths.
In this post, I discuss four psychological qualities that can help an investor succeed at investing. These qualities or traits are not something people are born with. Those who think they don’t possess these qualities can cultivate them through deliberate effort. And those who think they possess them can strengthen them through deliberate practice.
The four psychological qualities are:
- Commitment,
- Courage,
- Self-control, and
- Resilience.
Commitment
Commitment is essential for achievement in life, relationships, careers, and investing.
To commit oneself to an idea, activity, or cause, one must first be convinced that it is worth the effort: the contributions and costs one makes are justified by the rewards. There are two reasons why we hesitate to commit: 1) it places constraints on our freedom, and 2) whether the contributions we make will bring us growth or pull us down.
Heidi Reeder is a psychologist teaching ‘commitment’ for more than 15 years. According to her, commitment is the experience of being psychologically attached to something and intending to stay with it. Commitment is a process we can develop and strengthen when we need it the most. Any goal will make little progress unless supported by commitment. She points out four variables that determine our level of commitment: treasures, troubles, contributions, and choices.
Treasures are what we value about the activity or relationship, the thing that makes it rewarding for us. Troubles are the downside of the activity or relationship, the costs we incur along the way. Contributions are the personal or financial resources that we have already invested – the things we stand to lose if we decide to quit or move on. Choices are other options we may have and how attractive they are.
This is a wonderful framework we can use to determine the parts of our life where commitment levels need to be increased or reduced in a way that serves us well.
It applies to investing too. How successful you are at investing is closely correlated with your level of commitment.
The reward of investing is the wealth and financial independence that comes along with it. Investing means ‘your money is working for you’ instead of ‘you are working for money’. The rewards of increased freedom, less stress, and more quality time are worth the commitment we make toward investing.
The contributions you must make are committing your capital, time, and attention. When compared to other alternatives – spending and saving – investing is more rewarding.
Once you are seriously committed to investing, 1) you will have to regularly monitor your portfolio, 2) how the individual constituent stocks and their respective fundamentals are doing, 3) should you add a new stock to the portfolio by selling another stock, 4) which among the two stocks have the highest expected return?
These are the troubles you face once you commit to investing. When you put your money in bank deposits, you don’t have to go through all these troubles. You will keep receiving interest regularly with no effort required from your side (unless the bank fails, and in that case, you lose your entire money, but that is an extremely low probability event).
Courage
Fear is the biggest obstacle that stands in your path once you are convinced of the benefits of investing and decide that it deserves a high level of commitment from you. Fear can appear in many forms – the fear of losing money, fear of the unknown, fear of uncertainty, fear of making wrong decisions, fear of embarrassment, fear of failure.
Fear keeps you from doing what you should do. Fear is a basic emotion that everyone feels, but what distinguishes the brave from the timid is the ability to rise above it and master it. And courage is what you gain when you rise above your fear. Doing the right thing always takes courage.
It is normal to feel fear, but rather than staying afraid, withdrawing, or not acting, you need to be proactive and take the necessary action or decision. Once you go through this, the fear diminishes, and you gain courage. Courage is like any skill: the braver acts you do, the braver you become.
In investing, you may feel fearful, when you decide to invest in a particular stock, and that is normal. Of course, you will have doubts. But when you have done enough work and are convinced about the stock’s good prospects, you should act on it.
You may become worried about a stock in your portfolio for several reasons, and in those situations, you need to determine whether the worry is based on the right reasons or just based on fear. You need to resist the temptation to act if it is solely based on fear.
Emotions are investors’ biggest enemy. The ability to keep emotions away from interfering in your investment decision will play a large role in successful investing and the next mental quality we discuss can help you do that.
Self-Control
In the 1960s, a group of psychologists did a test among preschoolers that later became popularly known as ‘The Marshmallow Test’. In the test, the preschoolers were given two choices: 1) they could have one marshmallow instantly, or 2) they could have two marshmallows, but would have to wait for the examiner who leaves the room and returns after some time. Some preschool students choose to have one marshmallow immediately, whereas a few choose to wait and have two marshmallows.
Subsequent follow-up studies done in the 1980s and 1990s found that those preschoolers who waited for the examiner to return and received two marshmallows had more academic, social, and career achievements than the preschoolers who choose to have one marshmallow instantly.
The study found one group of preschoolers chose immediate gratification and received a lesser reward (one marshmallow), while another group used self-control and willpower to delay gratification and received a larger reward (two marshmallows).
The findings showed that the ability to delay gratification through self-control and willpower can have a significant influence on our later life. The findings apply, not only to preschoolers but also to adults, particularly in investing.
Investing is a long-term game. It requires you to stay invested in a quality stock so long as it has strong fundamentals, high earnings prospects, and fair valuation. The stock may take 3 years, 5 years, or even a decade to realize its full potential. During this period, there will be lots of instances when you feel discouraged and want to sell out, and it requires self-control of you to resist those impulses.
To succeed at investing, you must have a well-defined investment process: how to select a stock; when to buy a stock; track the fundamentals; and when to sell the stock. This process should be malleable to incorporate new knowledge gained through experience (of ourselves and others). However, the action more important than developing a process is following it through and that requires discipline, and the self-control and willpower we discussed above are what enables us to stay disciplined.
There will be a lot of things that promise immediate rewards, vying for our attention, during the invested period. There will be a strong compulsion to liquidate your investment and meet those ‘instant gratification’ demands, however, only a person with high self-control can resist those temptations, while those with low self-control fall for the trap.
Any person who has taken up an arduous task will surely know that they will face setbacks and problems on their way, however knowledgeable, skilled, committed, self-controlled, and courageous they might be. Many people give up a task when faced with setbacks while a few others stick with the task and continue the journey until their goals are achieved and the virtue that distinguishes them is resilience.
Resilience
Resilience is the capacity to withstand and recover from difficulties, and a resilient person does not give up on the first sign of trouble.
The most common mistake I have observed people make while investing in the stock market is giving up entirely on investing once they have faced a major setback. What they don’t know is that even successful investors, even after decades of market experience, face such setbacks occasionally.
A person who lacks resilience gives up on the first sign of trouble because they are unwilling to endure the pain that comes along with all setbacks and difficulties. But without pain, there is no gain. They fail to understand that, if they pay close attention, there are valuable insights embedded in the pain that can help them grow and gain strength. By giving up, they are giving up on an opportunity for growth.
Resilience is not just about enduring pain. It is more than that. Resilient people are purposeful and goal-oriented. They understand that they will face challenges, problems, and difficulties while pursuing their goals, and are aware of the accompanying pain, fear, and suffering.
But what differentiates them from others is that they believe that the only path toward their goal is to move through these challenges, problems, and difficulties. They endure the pain because they know there is wisdom that can be gained that can help them gain strength to overcome their challenges, solve their problems, or recover from setbacks.
And when they come out of this experience, they are not the same person that went into it. They have become more complex, there is self-expansion, they gain strength, and they are more resilient.
Suppose that you lost 50 per cent on a stock. We know that wasn’t your goal. Your goal was to gain 50 per cent or even more on the stock. But you lost 50 percent and that’s painful. Every time you check your portfolio, that stock will be staring at you, exacerbating the pain. Selling the stock and moving on does not solve the problem because you may go on to repeat the same mistakes. What is needed, and what resilient people do is that they reflect on the mistake, learn from the experience, and gain insights, so that they do it better the next time or at least don’t go on to repeat the same mistake.
Final Thoughts
‘Invest in Yourself’ is the best investment you can ever make, says Warren Buffett. Inculcating these four psychological qualities in yourself can be one way you can do that. You don’t first develop these traits and then invest. You start investing and then develop and strengthen these traits along the way.
The traits are mutually supportive. Strength in one trait makes it easier to develop the other traits. Commitment becomes easier for those with high self-control. High resilience gives you the confidence to take bold risks, and taking bold risks makes you courageous.
Every encounter you have with the market will be a test of these traits. Reflecting on these encounters is the best way to learn about yourself – your strengths and weaknesses. Awareness of who we truly are is the first step toward progress.
Investing is hard and nothing is harder than achieving superior returns from the stock market consistently. Investors with the right mindset will have the upper hand. People with the right mindset will identify and be curious about gaps in their knowledge and perceive every experience as an opportunity to learn.
AMN CAPITAL 
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