Warren Buffett and Emotions

"Pessimism is the most common cause of low prices. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It's optimism that is the enemy of the rational buyer."...Warren Buffett

Investing decisions that are driven by normal human behavior can have a deleterious effect upon long-term wealth accumulation. Many investors, even the most savvy, allow their emotions to get in the way of rational investment decision-making. Our emotions have the nasty habit of encouraging investors to buy and sell at the wrong time...causing us to buy high and sell low...which is the reverse of what should be done.

Three Common Behavioral Issues. 1. Herd Mentality reflects the natural tendency to do what is currently popular, e.g. buy securities AFTER the market has risen, or sell securities AFTER significant declines. Herding is defined as a group of investors following each other into (or out of) the same securities over a period of time. 2. Regret Aversion is the avoidance of the pain of regret associated with bad decisions. This trait causes investors to hold onto losing positions too long...or to avoid the markets during periods of depressed prices, at exactly the right time to invest more. 3. Mental Accounting is used by investors to build portfolios as separate accounts, and to disregard the correlations among assets. Investors do not evaluate investments based on the contribution to the overall portfolio return and total risk, but only upon the recent performance of the asset layer.

For long-term wealth-accumulation, investors are encouraged to think counter-intuitively. Contrarian investing and portfolio rebalancing are the most effective manifestations of counter-intuitive investment thought.

Speaking of rebalancing, in the May issue of "Financial Planning," there is an interesting article that discusses a new software program that performs sophisticated rebalancing techniques...that enhance portfolio returns even beyond what 'normal' rebalancing accomplishes.

Comments

[Nike Free Running]

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[Supra Shoes ONline]

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