Don't ever let someone tell you investing is a rational pursuit. Yes, it certainly should be, and that's the aim of every investor – to take the emotion out of our investment decisions. What you don't need me to tell you is that it's easier said than done.
Here are three ways to improve your odds:
Learn from others' mistakes
Firstly, investing is inherently uncertain. If it was certain, prices would only move in step with known facts, and their easily calculable impacts on future profitability. Devoid of that certainty, we're forced to make educated guesses.
Luckily for investors, we have a rich history of economic and investment theory to draw on. Whether you've taken investing lessons from Buffett, Lynch, Graham or one of many others, we have the luxury of being able to learn from others' mistakes and successes.
Through understanding the lessons that can be drawn from success and failure, we have the opportunity to tailor our investing approaches. The power of growth, the need for a margin of safety, and the importance of management and culture are lessons I've learned from watching and hearing from other successful investors.
Challenge your assumptions
Capitalism is characterised by creative destruction. The free market at its best continuously rewards businesses who create better ways of doing business, better products and lower prices, while old products and businesses fall by the wayside.
The free market by itself isn't the best place to create social policy and I'm not suggesting it can be allowed to operate unchecked, but that's a different conversation. The businesses encouraged and allowed to thrive by our system of capitalism have improved living standards, created employment and rewarded improvements through profits for those who have delivered those outcomes.
The flipside for investors is that we must always be alert for the first breaches of our companies' defences. Investors in buggy companies may have owned the best buggy maker in the business – the lowest cost, highest quality, most preferred brand in buggies – but that counted for little when the automobile came along.
Ignore noise – and the crowd
Lastly, the constant stream of stock quotes, news headlines and investment commentary (and yes, I understand the irony) bombard us with different messages. Optimism follows pessimism and improved profits come at the same time as uncertain futures. With so many seemingly contradictory messages, it's no wonder that investors' average holding periods for shares have dropped from years to months in the last couple of decades.
When the bears are cowering, we want to hide, and when the bulls are running, we feel safe in the herd. This groupthink leads to bubbles and sell-offs – and investors don't do well blindly following the herd in either situation – they find themselves unprepared for when the markets return to 'normal'.
My challenge
The personal challenge I've had in the past couple of weeks is one that will become more prevalent as the market rebounds in the rally to come. I was fortunate in October to see some of the shares I own move higher – a couple by double-digit percentages.
While it's a good problem to have, my inner cheapskate is now comparing the current prices against the lows of recent weeks, and I'm starting to wonder if I've missed the boat.
I try to invest small amounts regularly – and even though all of the shares that have rallied recently are still below their 52-week highs, I'm instinctively anchoring myself to the recent lows. As a result I'm finding myself reluctant to buy more – even though at their yearly highs, I would have welcomed a 10% dip as a buying opportunity!
Foolish take-away
Human psychology can be our greatest friend, but also our greatest enemy as investors. The tendency to see the grass as always greener, and to overemphasise the recent past at the expense of longer term experience are but two of the psychological obstacles to greater success.
This weekend, I'm going to take a fresh look at some companies whose shares have both risen and fallen in value recently. I'm going to do my best to ignore the recent past and work out whether today's prices represent good value.
My sneaking suspicion is that if I can successfully ignore the noise and critically analyse the business models and competitive positions of these companies, I'll find some current holdings that I should buy more of, and some new opportunities.
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Scott Phillips is The Motley Fool's feature columnist. The Motley Fool's purpose is to educate, amuse and enrich investors. This article authorised by Bruce Jackson.
