Category Archives: Psychology of the Deal

Investment psychology

Avoiding mistakes?

I suffer from analysis paralysis — a delusion that if I get enough data and study it enough, I can remove risk from an investment.

To deal with this shortcoming I talk to myself. More than normal ;). I remind myself that Mark Twain has an answer for every occasion. In this instance he said

Good decisions come from experience
Experience comes from making bad decisions
— Mark Twain

What a neat concept. Click comments and let me know what you think of that.

Crystallizing losses

I recently read a piece of marketing fluff posing as research from a financial advisor. It recommending holding firm in the face of losses in the stock-market to benefit from the bounce back.

A lot can be learned from how an investor reacts to losses and continuing uncertainty.

One option is to hold tight. All markets have historically turned around so eventually the investment come good.

The other option is to sell and crystallise a loss. Wipe the slate clean and begin again. Remember you may be eligible for a tax deduction on the loss (capital or income).

Thirdly it may be possible to sell part of the investment and holding part. Let’s ignore this for now. Just note you may want to do that.

What are the risks of following either strategy?

The first exposes investors to ruin if the investment collapses and below-average long-term returns if it plays catch up.

The second strategy leads to over-trading. Nobody can time the market perfectly over a long period of time. Transaction costs of entering and exiting investments can be exorbitant.

I am constantly evaluating investment opportunities. My money must work so hard it sweats. Therefore I prefer to cut losers free and allocate the funds elsewhere. This only works if I identify a better investment. If I don’t have an alternative need I ride out the storm.

I do head-miles when I make a bad investment decision (for that matter I do mental gymnastics when a deal goes well). I take pride when I admit my error and get on with life; reminding myself that investing is part of life.

As I make more investment decisions, they become easier. It also gets easier to deal with the inevitable mistakes.

Ask yourself how do you deal with your mistakes. Don’t try to act in a way inconsistent with your values and makeup. Look for what makes you feel physically uncomfortable. Compare crystallising a 10% capital loss followed by a 20% gain to the thought of holding on for a year or two until the poor performer turns around and goes up 8%. This is the same result via different paths.

Strange questions from smart people

I was writing and publishing paper-based ‘zines and newsletters back when the Apple Macintosh was first released. They were a beautiful piece of kit and introduced the phrase WYSISYG to the world (What You See Is What You Get). Strangely, new writers asked published authors which computer to buy to write their novel.

Did you know that Jack Kerouac typed On The Road on a big roll of paper?

I progressed to publishing children’s books and adult non-fiction. Again the questions were about the tools not the technique nor discipline. I moved on to writing, editing and reading movie scripts. This time I was asked how to bind a script, what font to print in, whether to use US Letter or A4 paper.

These days I build businesses and invest in creative real estate like wraps. I get more questions about what software I use to track buyer’s payments than I get on negotiating strategies.

I think this is because we need to feel in control of our environment. Investing involves conquering fear and taking action. I always feel butterflies in my stomach until I take that step. In the early days, my response was to look for something to explain that discomfort. I used to hunt desperately for anything to logically hang that feeling on. Until I recognise what happens in my guts, I waste time and energy fixing problems that don’t exist. Am I installing an accounting system because I have legitimately identified a shortcoming? Or is it something from the to-do list that feels like progress?

However fear is not logical. Logic can sometimes overcome fear, but it really takes courage to recognise the situation and take action in the face of fear. If this step is missed, we don’t learn from our previous deals. The internal battle must be fought for each new deal.

Am I counselling a headlong rush without considering support systems? No, of course not. Take the time to set up, NASA is a good example – the countdown doesn’t end at zero.

The mission begins with Lift-off…; T+1…; T+2…; T+3…

Your preparation steps are for the main show. Focus on what gets you paid.

Beginners win while others get burned

Surprisingly often, beginners do good first deals in real estate, the financial markets and business.

Why? Answer by clicking comments, but I’ll lead off with a fairly analytical approach.

My theory is successful newbies are cautious and actually begin. What do I mean by this?

Character traits of the cautious:

  • Have an inbuilt drive to do some sort of research (also known as due diligence);
  • Discover (or formulate) some simple guidelines;
  • Understand the investment enough to describe it simply;
  • Consult with experience;
  • Take responsibility for their decision.
  • Beginners who begin:

  • Overcome analysis paralysis;
  • Deal with the fear of making mistakes;
  • Take action until they get results.
  • Then what happens? Intermediate investors overestimate their abilities once they gain knowledge. Did you know that most people rate their driving ability as “above average”?

    Investors tweak their system. Instead of following the simple guidelines that led to success in the first place, they make adjustments. The strategy becomes a patchwork of plans. Few intermediate strategies can be articulated in one sentence.

    Experience leads to on-the-fly decisions, because overconfidence creeps in. This allows emotion to take over the rational decision-maker. Greater risks are taken to avoid a loss and exit strategies become poorly defined

    Three steps for Intermediate Investors to avoid the trap.

  • Express your strategy in one sentence. e.g. “buy big cap stocks with a P/E under 12 and a Price/Asset ratio over 1” or “3 bedroom houses within 10kms of the CBD with a yield above 6.5%”.
  • Build on the basics. Musicians practice scales and exercises as the building blocks of performance. Your wealth creation strategy is the same.
  • Use a written plan to outline the deal. This forces you to think ahead, remove emotion from the process and develop an exit strategy.
  • A Metaphor for Mastery

    I used this metaphor back when I ran courses. So here’s a freebie.

    Remember when you learned to drive?

    As a child you were Unconsciously Incompetent. You didn’t know how to drive and didn’t realise it.

    Consciously Incompetent – your first time behind the wheel. You didn’t know how to drive and hooboy do you know it!

    Consciously Competent – Somewhere between L’s and P’s. You can drive, but nobody is allowed to talk to you while you do it. You can drive but it takes all your attention to keep doing it.

    Unconsciously competent. Drive, talk, eat, abuse other drivers and check the street directory AND street signs. Did you really pay attention to every gear change and turn on your last drive. Yes it is mastery, but it happens without your attention.

    To bring this back to your WealthEsteem…

    Learning a skill takes attention and experience. Eventually experience takes over and requires little attention.

    Investing takes courage to begin or return to after a setback. Experience teaches you to say “What else can I do?”

    Hope you apply it.

    Nobody knows anything – William Goldman

    William Goldman opened his best-selling book Adventures in the Screen Trade with “Nobody knows anything”.

    Goldman writes movies. Good ones. His filmography to date according to the Internet Movie Database:
    Hearts in Atlantis (2001) (screenplay)
    General’s Daughter, The (1999) (screenplay)
    Absolute Power (1997) (screenplay)
    Fierce Creatures (1997) (uncredited)
    Ghost and the Darkness, The (1996) (written by)
    Chamber, The (1996) (screenplay)
    Maverick (1994) (written by)
    Chaplin (1992) (screenplay)
    Year of the Comet (1992) (written by)
    Memoirs of an Invisible Man (1992) (screenplay)
    Misery (1990) (screenplay)
    Princess Bride, The (1987) (also novel)
    Heat (1987) (also novel)
    Mr. Horn (1979) (TV)
    Magic (1978 ) (also novel)
    Bridge Too Far, A (1977)
    Marathon Man (1976) (novel)
    All the President’s Men (1976)
    Great Waldo Pepper, The (1975)
    Stepford Wives, The (1975)
    Hot Rock, The (1972)
    Butch Cassidy and the Sundance Kid (1969) (written by)
    That is one impressive list of credits. What has it got to do with wealth creation?

    Goldman was talking about the film business and picking winners. His dictum applies to any industry where the results are affected by the interaction of huge numbers of people. Sort of like the property and stock markets and the business world.

    After the event economists tell us why the economy changed. Bankers explain movements in interest rates. Stockbrokers clarify market gyrations. All with 20/20 hindsight. Popular prognosticators make dozens of predictions then point to the ones they got right.

    People ask where is the next boom? Which suburb will take off? What IPO is the next Microsoft? Repeat after me “Nobody knows anything”.

    The keyword is “knows”. Knowledge! Facts! Data! Wisdom! If analysis could give accurate predictions, we wouldn’t have booms and busts. Pricing information would be accurate. But certainty is impossible. Fool yourself into believing in certainty and I guarantee an expensive lesson. People who are certain get lazy and inattentive. They miss warning signs. They also get bored and meddle with a working system.

    Figure out a plan to go forward. Consider your entry and exit strategies. What happens is it all goes pear-shaped. If you find yourself saying “that will never happen” then ask “but what will I do if it does?”

    In 1991 I bet the farm that no federal Labor government would allow first mortgage interest rates to hit 18%. History proved me wrong and I lost a million dollars. Now I look at a deal and have exit strategies for good, bad and neutral scenarios. That way I deal with “what is” not “what should be”. If the unexpected occurs, I throw out the strategies and get creative.

    Power lies in the ability to make drastic changes in the face of new and overwhelming obstacles. Think fast and use imagination to tap that power. Quit wasting energy and time trying to predict the future. Get out and have a go.

    Lastly remember this:
    Some people watch things happen;
    some people make things happen; and
    some people wonder “what happened?”

    Which one are you?

    WealthEsteem’s 12 Life Insurance Rules of Thumb

    American Express called Nella this week. They’re selling a life insurance policy. So here are a dozen Life Insurance Rules of Thumb.
    1. For the Term of his natural life? Jargon Busters
    Term Life Insurance is a straight-up insurance policy. You die (or some other defined incident) and the insurer pays money. Whole of Life Insurance has a savings component and surrender value. Commissions, fees and charges are higher on Whole of Life, plus it takes about 20 years for Whole of Life to offer a decent return.
    What to do?
    a) [i]Buy term – invest the rest[/i]. Note that second phrase.
    b) Build your asset base to provide sufficient income, until insurance is [b]no longer required[/b].

    [b]2. Never buy insurance from telemarketers[/b], or [i]On sweatshops and boiler rooms[/i].
    How much money would it take to make you ring people at home in the evenings to sell stuff? They can’t pay me enough.
    Nella used to sell trade magazine advertising over the phone. Nella gave great phone for great commissions. Telemarketing is an expensive business and premiums pay for it.

    [b]3. Cheap and “easy”, “no medical” insurance isn’t[/b], or [i]What free lunch?[/i]
    Online, I compared three Term policies from two insurers monthly premiums.

    Amount Co. A Co. B
    $100,000 $15.07 $12.30
    $200,000 $22.65 $24.60
    $300,000 $27.28 $35.98

    Most brokers can get an average person $500,000 coverage for the $300.000 premium.

    [b]4. Don’t smoke[/b], or [i]Can you say Yule Brunner and Steve McQueen?[/i]
    You know it kills you? Well your insurance company knows it. Smoking will add about 75% to your premium. I know it’s “Yul Brynner” but you’d be surprised how many people search Google with the misspelling.

    [b]5. TPD?[/b] [i]Better than ADD[/i].
    Total and Permanent Disability cover is expensive and full of “exclusions”. That’s insurance speak for reasons not to pay you. However it is nice to get paid as soon as something bad is diagnosed. So I have Term Life and a much smaller $100,000 TPD cover. Should a bad thing happen I get money for treatment and to put my affairs in order. Term cover will then pay out when the end comes.

    [b]6. Only insure income producing assets[/b], or [i]Do you want fries with that?[/i]
    Brokers love to upsell. Your home-maker spouse allows you to work and you’d miss them on cold nights. Don’t insure them unless they make mortgage payments. Invest the premium instead.

    [b]7. Review your insurance at least every two years[/b], or [i]know when to fold ’em[/i].
    Once your assets are feeding you, do you really need half a million in Term Life? Thinkaboudit!

    [b]8. Income Protection Insurance[/b], or [i]You don’t need it, till you need it.[/i]

    Can you afford 6 months unable to work? Would your investments eat you? Watch out for medical history excluding you on this.

    [b]9. Get Term Life before 34 but not too soon[/b], or [i]How old am I again?[/i]
    Most people can qualify for Term Life before 34. Does a 23 year-old without obligations need it? No.

    [b]10. Start investing[/b], or [i]That means today, slacker![/i]
    Do something about it today. Insurance companies only write business for the cashflow to invest. There’s a lesson in that.

    [b]11. The most powerful force in the universe?[/b], or [i]Up, up and away[/i]
    Compound interest. There’s an article in just this. You do know that at 10% p.a. you double your money every 7.2 years?

    [b]12. Add you’re own[/b] or [i]Whose life is this anyway?[/i]
    I can’t tell you everything or you won’t learn. Get a piece of paper out and write a plan. Now. I’ll wait…

    Then add a reply down there with the suggestion…

    I’m waiting…

    Really…

    Psychology of the Deal

    Welcome to WealthEsteem — dedicated to the Psychology of the Deal.

    What does WealthEsteem mean to you?

    These are my musings on wealth creation, written during the quest for my second fortune. If my ideas work, great! See you in Monaco sipping Cosmopolitans. If they don’t, it’s a map of my folly. Hoist a cool drink to my memory and imbibe responsibly.

    For the record, I made my first fortune by the time I was 26 and lost it and more by the time I was 27. The details should emerge in the Diary as time goes on.

    I may publish a monthly newsletter. Subscribe to it by sending an email to @wealthesteem.org with “subscribe wealthesteem” in the body.