Welcome back to our series on the 7 Principles of Long-term Investing. If you haven’t read the first two, or if you want a refresher, you can find them here and here.
The first principle – focus on the total return of your investment – provides a great foundation for the ones that follow, including today’s; Don’t chase the crowd.
Be Aware of the Hype
Why is it you never put complete faith in a weather forecast? Because most of you have enough real-world experience to know that doing so is a fool’s errand. There are too many variables that cannot be controlled, so meteorologists use models – sometimes several – to build a forecast. But, still, forecasts are not perfect, and we are all required to use a little common sense. The same is true for investing.
Watch any of the financial shows and you’ll see analyst after analyst offering their opinion of the next hot stock. Now for a little secret, if the TV analysts are talking about it there’s a good chance the institutional investors already have it on their radar and are moving money into it to take advantage.
The same goes for your friends, family, neighbors and coworkers. By the time they are investing in the latest trend, they’re not getting in on the ground floor. They are several stories up and there’s very little room before you hit the ceiling. Put another way, whatever the hot thing is – a stock, security or sector – the price has already been inflated by the hype.
Remove Emotion
We aren’t suggesting you ignore the TV analysts or your friends and family, but the hype around their recommendations usually leads to decisions born of emotion rather than reason. And emotion and money do not mix well. Savvy investors seek objective, independent research that uses the best information available, calculated choices and a realistic assessment of risk and determination to avoid making decisions based on purely emotion. As we’ve said in previous posts, investing requires thinking and panning for the long term. Chasing the latest shiny investment object is anything but. This is the reason it is critical to test every decision against the first of our seven principles.
When faced with the opportunity to chase an investment trend, ask yourself if doing so is putting the total return on your investments in jeopardy. If you answer “no” to that question, follow what the savvy investors do. Research the trend using more than one objective source (3-4 is optimal). Decide what level of risk you are willing to take with your investment dollars. Remember, crowd chasing can lead to lower returns, so you must be willing to sacrifice the potential for higher returns if you invest those same dollars in a different investment vehicle.
Conclusion
We said it earlier, but it bears repeating, money and emotion do not mix. Unfortunately, that truism can be lost in the crowd when it is rushing to pour investment dollars into the latest hot trend.
When you see that happening, when your friend and family are telling you about all the money to be made by going along with the crowd, that is when you, the savvy investor, takes a deep breath and recalls the first principle because you know it is better to assess the trend than to join it based on the lure of short-term gains.
Remove emotion from the equation and buy yourself the time needed for the due diligence necessary so you can make a rational decision based on data, reason and what is best for the long-term health of your portfolio.
