I’ve often remarked that your psychological state can be your portfolio’s harshest enemy—and today, I want to elaborate on why understanding this is essential and how you can protect yourself from it.
Don’t Dismiss All Your Thoughts
First, we must identify this invisible adversary. I’m certainly not suggesting you ignore your brain altogether. Instead, what I advise is to dismiss emotional decision-making.
To illustrate this concept, let’s refer to a metaphor introduced over 2,500 years ago by Buddha: the “Monkey Mind.”
For those inclined toward scientific explanations, I’m largely touching on the role of the Limbic system here.
Tim Urban from Wait But Why offers a memorable explanation:
“The limbic system is a survival mechanism. A good guideline is that whenever you’re engaging in activities—like eating, drinking, or fleeing from danger—your limbic system is likely in control.
When internal conflicts arise, it’s often the limbic system urging you to act impulsively—decisions you may later regret.”
In today’s letter, I’ll address how to manage this “Monkey Mind” specifically in the context of investing.
The “Monkey Mind” is that part of you that reacts to headlines like “STOCK MARKET AT AN ALL-TIME HIGH!” by urging you to buy more stocks, or conversely, it screams to sell when the market dips.
The Monkey Mind is emotional, impulsive, and reactive. It’s vital that you learn to ignore it.
Jim Paul summarizes this perfectly: “Following your plan imposes discipline over your emotions. If you don’t have the discipline to execute your plan, then your emotions are steering you.”
Insights from “What I Learned Losing a Million Dollars”
Recently, I revisited a book recommended by Nassim Nicholas Taleb, called “What I Learned Losing a Million Dollars” by Jim Paul and Brendan Moynihan. While the book focuses on a type of investing I don’t particularly endorse (which I consider betting), it offers valuable lessons on what to avoid in all forms of investment.
Jim Paul made numerous mistakes in his investing journey, but you can learn from his experiences and steer clear of similar pitfalls.
Paul shares a valuable perspective: “When I was a kid, my father taught me two types of people existed: smart people and wise people. Smart people learn from their mistakes, while wise people learn from the mistakes of others. By reading this book, you gain the opportunity to become wise.”
Why Focus on Mistakes?
There are countless approaches to investing, and what works for one may not work for another. However, successful investors often share several key habits that can guide us in avoiding common errors.
Let’s focus on what you should avoid:
What Not to Do
Keep in mind that your Monkey Mind is your biggest adversary in investing.
1. Don’t Internalize Failures
If you lose money in the market—something that will inevitably happen—resist the urge to doubt yourself or your decisions.
Instead, take a step back and evaluate the situation objectively. Ask yourself:
- Why did my investment decline?
- Could I have mitigated this loss?
- Was this part of a larger strategy?
For instance, I anticipate a stock market crash within the next two years. When that happens and I see my portfolio’s value drop, I must remind myself that these downturns are part of the normal market cycle.
If I allowed my Monkey Mind to take over—screaming “What are we doing? Sell everything!”—I would convert an external loss into a personal crisis.
By implementing a strategy to hold my investments for a minimum of 30 years, I can stick to my plan and keep that impulsive Monkey Mind at bay.
2. Distinguish Different Types of Risk
Understanding whether you are investing, speculating, or gambling is crucial.
Jim Paul articulates this well: “The key difference is that gambling creates risk, while investing and speculating involve managing pre-existing risks.”
If the market slips, it’s expected; these fluctuations happen frequently. However, if I were to hastily purchase individual stocks based on fleeting trends, I would being gambling rather than investing.
Ultimately, knowing the nature of your financial decisions is vital.
3. Avoid Emotional Decision-Making
This involves acting impulsively due to external pressures.
For example, let’s say my plan was to invest 90% of my portfolio in index funds. If I suddenly hear buzz about an upcoming IPO, I might be tempted to divert funds into a riskier investment.
This is a clear manifestation of Monkey Mind directing my actions away from my original strategy.
Reinforcing discipline and sticking to a well-considered plan is crucial to managing your emotions and ensuring investment success. Paul’s insight is poignant: “If you’ve ever strayed from your intended course and acted impulsively, you were likely swayed by the psychology of the crowd rather than your own deliberate thinking.”
In Conclusion
Today, we learned:
- The Monkey Mind is a detrimental force in investing.
- Understanding what not to do is crucial for successful investing.
- Many of your investment mistakes will stem from psychological challenges.
- Key strategies to avoid letting your emotions dictate your financial decisions.
That’s it for today!
Let me know if you need any further adjustments or additional information!