Bluefield Daily Telegraph, Bluefield, WV

Washington Post Features

October 1, 2012

6 rules of investing

(Continued)

NEW YORK —

3. Understand crowd behavior: The investor who understands the behavior of crowds has an enormous advantage over one who doesn't. He understands that investing often involves figuring out where the crowd is going, even if it's objectively "wrong."

Investing isn't necessarily a process of picking the "best" asset class, sector or stock, but rather, selecting what the crowd is buying. Investors sometimes forget that, most of the time, the crowd is the market. (You can take advantage of this by, as Rule 6 suggests, becoming a index investor).

The psychology of crowd behavior is such that higher prices attract more buyers — and lower prices create sellers. Fear of missing a rally is a powerful element; fear of losses is even stronger.

4. Think like a contrarian: The crowd can be fickle, overly emotional or even irrational. The contrarian learns to recognize when the crowd turns into an unruly mob. When that happens, it's time to stop betting with the group, and take the other side of the trade — betting against the crowd.

Most people accept conventional wisdom at face value, tend toward widely accepted social mores and are uncomfortable being lone voices of dissent. There is an evolutionary reason for this: Humans are social animals, and we have evolved to cooperate with the members of our tribe and to work with the group.

But there is a qualitative difference between what the majority of rational-thinking market participants are doing and the reflexive, panicked behavior of an unthinking mob. The true contrarian can tell the difference between a crowd and a mob, a market rally and a bubble. The tricky part is the timing.

5. Asset allocation is crucial: What is your relative weighting of stocks, bonds real estate and commodities? In the popular finance media, this gets little attention. Yet all of the academic studies show that it's the most important decision an investor makes. It's far more important than stock selection, yet that's all anyone seems to want to talk about.

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