Emotional investing rarely leads to successful investing.
What is your fundamental investing style? We're not talking about whether you're a "value," "growth," or "head-in-the-sand" type, but the essential label that defines the way you manage your money.
In other words: Are you an investor? Or are you a speculator?
First, a quick refresher:
- Investors buy into solid businesses in the expectation that we will be rewarded over time via share price appreciation and dividends.
- Investors don't try to time the market, and we certainly don't speculate when we buy shares. Speculation is what City traders do -- incidentally, the same City traders who destroyed billions of pounds of value at Lehman Brothers, Lloyds Banking Group (LSE: LLOY), and Royal Bank of Scotland (LSE: RBS).
- Investors recognise that game-changing events sometimes -- but not always -- require immediate action. So when the markets occasionally convulse, calling into question the soundness of the companies in our portfolio, we rationally assess what it all means for each holding's long-term financial health.
- Lastly, as investors, we constantly remind ourselves that we're in it for the long haul -- through all the hand-wringing and belt-tightening.
So, are you or aren't you?
During times of high volatility like we've seen over the past week or so, even the strongest-willed investors unconsciously drift into speculator/trader territory. They grab the nearest lamppost until their knuckles turn white, and when they think the coast is clear, they make a mad dash toward the nearest exit.
Can you blame them?
It's hard not to feel like helpless bystanders watching Extreme Market Makeover from our armchairs -- because in many ways, we are. We can't control what the market does any more than we can control the weather. Emotions are ruling the day. And emotional investing rarely leads to successful investing.
But we investors know that plenty of factors are completely under our control -- important things like what and when to buy, sell or hold; how much money to commit; how long to stick with it; and under what circumstances we'll reconsider each of these things.
Still, there's a big difference between believing and doing. Hence, a lot of people who call themselves investors are acting a lot like speculators these days. One day they are buying commodity shares like Vedanta Resources (LSE: VED) and Kazakhmys (LSE: KAZ) because they think the Chinese infrastructure boom will go on for decades, and the next they are selling because of nervousness surrounding the Greek debt problems.
As a result, the long-term prospects of great businesses are getting very little consideration. Remember the old adage: "Price is what you pay; value is what you get." It applies to the current situation in spades. Yet this point seems to have slipped a lot of people's minds.
Investors know that what we've seen happen during the past few weeks is a wholesale revaluation of many companies' share prices downward. Note that we said share prices, not values. There's a big, big difference between the two. Investors know the difference. Speculators do not.
A simple exercise for those moments of weakness
We know that acting like a bona-fide investor is no small feat these days. It requires constant, conscious vigilance, and daily (sometimes hourly) reminders of what it really means. When you feel yourself slipping into a speculative frame-of-mind, try this simple exercise:
Take your worst-performing investment to date or, really, any investment that is interrupting your sleep. Write down why you bought the business in the first place. Ask yourself: What did I find attractive about it at the time? Has any of that fundamentally changed?
If you own shares of BP (LSE: BP), for instance, chances are you bought them for their stability, their value and their above-average dividend. Those reasons more than likely still apply, although the company may be facing some near-term headwinds as the demand and price of oil take a dip. But essentially, the share price is now a little lower than it was, though the company remains the same.
Long-term investors thrive on this opportunity: the chance to buy the same business for much cheaper. Buying on the dips, you should be able to lower your cost basis considerably in companies you already own. (Yet another thing investors love.)
Granted, it's not easy to make yourself see those share price dips in a positive light.
But remember: Short-term gyrations in the stock market have little relevance to winning long-term investments and long-term wealth generation.
That's exactly how an investor thinks. And that's exactly what you are -- an investor.
More on the economy and the markets:
> If you're in the market for buying shares, consider opening an online broker account with The Motley Fool's Share Dealing Service. You can buy and sell shares in real time for a flat rate of just £10. Click here to find out how you can open an account for free today. There is no obligation to trade.
> A version of this article was originally published on Fool.com. It has been updated by Bruce Jackson.
