Digital Wealth

Chapter 18 Your Own Worst Enemy Is in the Mirror

“The key to making money in stocks is not to get scared out of them.”

—Peter Lynch

Most people know how they should invest, but few actually do so. Behaving rationally is hard when it’s your money at stake and especially when you’re losing it. Even though these short-term losses are typically temporary in the context of a broader strategy, that doesn’t make it any easier when it’s happening.

The Biggest Threat to Your Returns Is in the Mirror

One of the biggest problems for investors is market timing. This means taking a view on which way the market is going to move next. The basic problem is that market timing can leave you out of the market when it is rising in value and be a drag on performance. The trade to exit is fairly easy. You worry about something bad that will happen or see a large price fall and you sell your shares. The problem is that getting back in is harder. Emotionally, you want the trade to work, so you are tempted to stay out of the market waiting for a move down if one doesn’t happen.

The reverse problem occurs as markets rise. It can be easy to stay the course when the market is rising. In fact, it seems so easy that you believe you have more risk tolerance than you actually do. Risk tolerance is hard to truly measure until the markets are falling. Fear of missing out on returns starts to drive your behavior; you check your portfolio more frequently and are tempted to do more short-term trades. Since ...