Success is often the result of a culmination of all the decisions that you make. Improving your decision making will your results. There's an almost endless search to improve our decision making, especially when it comes to money, most notably, our decisions about our investments.
Can you learn to make better investment decisions? There are some keys to making better investment decisions that you can learn. They require awareness, discipline and practice. Here are 5 concepts you should be aware of that you can focus on to improve your overall decision making:
1. Tomorrow will not be the same as today- in the world of behavioral economics this is known as recency bias. We tend to make our decisions based on the latest available set of information we have at our disposal. The world is a constantly evolving place, and then by default, today's information won't be tomorrow's information.
How might this affect you as an investor? Don't base any of your long-term decisions on "good" or bad" news about a company or an industry based on today's headlines. That makes it an emotional decision. Stay focused on your long-term thinking and strategies. The ability to stay-the-course will keep you from the perils of both over exuberance and overt pessimism.
2. Use short-term goals to achieve long-term results- we'd all benefit if we could focus more on the things that we need to do to improve our situation and less on how our investment returns are doing. Being consistent, or even better, making small improvement in the things that we can control, such as savings and spending, will be at least equally as important as how your investments are performing.
3. This time is just like last time- in a rush to find answers we often link events that have no real reationship to each other and then we draw the wrong conclusions, leading to poor decisions. The 2008-2009 market and the 1987 market downturn is an example. While certainly there were things about each of these times (like they went down a lot and you were scared) that were similar, there was really almost nothing similar beyond that as it related to the overall market conditions. Many investors decided to "get out" of the market, thereby selling low; and then jumping back in after the market had recovered which meant that they were buying high.
4. Believing that you can pick winners- over-confidence in our own abilities often leads us to believe that we can pick winning investments, be it stocks or funds. History shows that we can't pick enough winners enough of the time to craft a winning long-term strategy. Building an investment portfolio is like building a business team, a sports team or any other high performance group; go for consistency across the board and let your heroes/winners rise to the top from amongst a group of high quality, well informed choices.
5. Unlinking Risk and Return- we almost always lose sight of the inexorable link between risk and return. On average, we want our investments to earn more money than the risk we're taking to own them. Wouldn't it be great if we could find investments that had the potential to earn 10% but would never go down in value? Well the reality is that risk and return go hand-in-hand so expect that there'll be volatile times and don't over react to the inevitable down turns that come when you're building a portfolio for long-term growth.
Sound decision making in investing comes down to a host of things that only partly have to do with your investments themselves. Success is based on the decisions you make as much as anything else. Make sure that your decisions aren't clouded by the emotional issues related to the five concepts I covered today. Base your investment decisions instead on long-term strategic objectives and a prudent financial plan.