Thursday, March 11, 2010

Do you have the temperament to invest in the stock market?

'The most important quality for an investor is temperament, not intellect. You need a temperament that neither derives great pleasure from being with the crowd or against the crowd.' - Warren Buffet

There are several definitions of the word 'temperament' in the Merriam-Webster's online dictionary. The one most appropriate for an investor is: Characteristic or habitual inclination or mode of emotional response.

Do you feel elated when a stock you have picked rises 50% within a short time after you buy it? Of course you do, but what you do next is crucial. Do you buy more? Do you sell it all and book short-term profits? Do you sell a little and hang on to the rest? Do you hold on to all for much bigger returns?

What if the opposite happens and the stock dips by 20% immediately after you buy it and starts to drift down further? Do you have sleepless nights thinking about how you will recoup your losses? Do you sit tight, convinced that it will rise back up sooner than later? Do you buy more to lower your average cost of holding? Do you admit making a mistake and sell it at a loss?

Trying to answer these questions honestly (that means, no cheating allowed) to yourself will reveal what kind of an investor temperament you have.

In an article published in The Journal of Investment Consulting in 2004, Statman and Wood adapted the Keirsey Temperament Sorter that groups people into four main characteristics:-

1. Guardians are adept at logistics - managing, organising, checking and supporting. They tend to be savers and mostly invest in less risky fixed income instruments.

2. Artisans are good at tactics - troubleshooting and manipulating instruments and equipment. They often save less and make aggressive investments in stocks and mutual funds - which can lead to great fortune or total ruin.

3. Idealists shine in diplomacy - clarifying, unifying, inspiring, counselling. They are averse to risk and money may not be a priority in their lives.

4. Rationals excel in strategy - conceptualising, theorising, engineering, coordinating. Their analytical approach leads to some success in the stock market but the irrationality of markets can upset their plans.

I'm not expecting investors to suddenly become experts in psychology or behavioural science. But it may not be a bad idea to introspect and find out about your innate nature and understand your emotional responses to the ups and downs in the market.

By learning more about yourself, you will learn to be a better investor.

Related Posts

Become a successful investor by avoiding 'herd mentality'
The Hare (investor) and the Tortoise (investor)

1 comment:

Eswar Santhosh said...

My answer depends on what I am doing:

If I am investing, then I almost always hate it if the stock goes up. Even if the Sensex goes up 1000 points, I like my stock to correct 10%. As long as it's either consolidating or correcting and I am investing, no issues for me.

If I am "investing" i.e., betting money without proper study, tips, trading calls, newsletters, risky bets, other's calls... then I'll be worried if it dips. Mind gets emotional and starts to worry about the "tip giver" off-loading his shares. Or it may get abundant joy over my great "power" of putting in Rs. 1000 and bringing down India's market cap as a whole. In short, this one is real exciting compared to the normally boring process of investing. Of course, I've (of late) tried to keep this exciting part close to naught or irrelevant in the overall context of my portfolio.