By Warren Ingram, CFP®
In the world of investing, a fundamental point is often overlooked: to become a great investor, you must learn to be a good loser. This lesson transcends financial theory and taps into the very core of human psychology. Understanding your emotions and tolerance for losses is crucial for anyone seeking success in the tumultuous investment world.
Losing money is much more painful than making money.
Many sporting giants can tell you about all the significant losses in their careers. These losses seem embedded in their memories, and even decades later, they still relive the emotions of losing much more vividly than they remember the joy of their big victories. These sportspeople are not unique, but they provide excellent examples of a phenomenon called loss aversion bias. Daniel Kahneman, a pioneer in Behavioural Finance, taught us that the pain of losing is so high that we will often do anything to avoid it again. According to Kahneman’s research, the pain of losing money is felt approximately twice as intensely as the pleasure of making an equivalent gain. This psychological asymmetry has profound implications for our investment decisions. The fear of experiencing losses can drive investors to make irrational choices, prioritising the avoidance of further losses over sound investment strategies.
Become a good loser
Being a good investment loser means becoming comfortable with the inevitable setbacks of the investment journey. You must accept that you will experience losses occasionally (hopefully temporarily) and that this is part of the process. When you are losing money, you must remain invested to profit from market recovery. By resisting the urge to make changes in response to losses, investors can position themselves for success over the long term.
Embracing losses is easier said than done, especially when certainty is rare. We crave predictability and often look for forecasts and projections to feel comfortable and confident. The reality is that uncertainty is an inherent aspect of investing. Rather than attempting to predict the future, investors should focus on factors within their control, such as time horizon and diversification.
Time and diversification are your secret weapons.
You cannot programme yourself to become immune from emotions. However, you can make some strategic decisions before investing that could help you. First, you must be prepared to invest for a long time – the longer, the better! If you can decide today that the money you will invest will only be used in 20 years, you have a great chance of achieving real capital growth. The second decision is to invest across many types of assets and geographies so that you reduce the emotional impact of one event that is unsettling you and your whole strategy. How much would an election in India impact you if you only have 5% of your money invested there? What about having 99% invested in South Africa during an election year?
An investor with a diversified portfolio spanning different asset classes and geographies is better equipped to navigate the market’s uncertainties. While it is impossible to eliminate losses, strategic diversification minimises the impact of any single event on the overall portfolio.
In conclusion, becoming a good loser is not merely desirable for investors; it’s a prerequisite for achieving investment success. By acknowledging the inevitability of losses, embracing a long-term perspective, and diversifying strategically, investors can fortify themselves against the emotional pitfalls of investing. Avoiding bad decisions in difficult times is a big part of successful investing. If you ignore this and only focus on finding winners, you might struggle to adjust when events work against you.
Written by Warren Ingram
CFP®, Wealth Manager, public speaker, and author. Host of the Honest Money podcast. FPI South Africa Financial Planner of the Year 2011.
