Good investor, bad investor

Imagine you are sitting at a poker table playing Texas Hold'em heads-up (i.e. one on one).

You get dealt two aces. You go all-in. Your opponent calls. He has two kings. The dealer lays out the 5 community cards and there is a king in it.

Your opponent makes a set (triplet) and you lose.

What are you thinking now?

Are you re-evaluating your decision?

May be it would have been better to bet a smaller amount instead of being too aggressive and going all-in.

Or perhaps you should have waited before some cards were out and then taken the decision accordingly.

If so, then you are confusing outcome with process and result with strategy.

Poker is a game of probabilities and you can make the correct play yet lose the hand.

However, a bad poker player will continuously tweak his play according to his recent outcomes.

Did it work out? If yes then let me keep doing that. If no then I need to do something different.

For a good poker player however, strategy comes first.

Based on her research, she knows that going all-in with Aces is the right play (with a win probability of >75%) and she would do it again even if it did not work out the last time (or two or three...).

How do they measure if they are doing well then, if not by their (immediate) gains and losses?

By having a different mental accounting. They count it as a win every time they follow their strategy (even if they lost money). They count it as a loss every time they don't follow their strategy (even if they got lucky and won the hand).

On the other hand, a bad poker player does not want to do the homework of researching the right strategy. It's much easier to just go with the flow.

Sounds familiar?

Investing, like poker, is a game of probabilities.

In any given year there is a range of outcomes that can happen which may have nothing to do with the quality of your investment strategy.

But a bad investor skips the strategy part. He just keeps making decisions based on recent outcomes.

Bad investor thinking manifests itself in many ways -

  1. Let me invest a small amount in this Mutual Fund now. If it does well in the next 3 months, I will add more otherwise I will look for another one.

  2. I started investing and the markets went down. This seems too risky. Let me stick to FDs.

  3. One of the stocks I bought is up 100%. Mutual Funds are for suckers. Let me put all of my money in stocks.

  4. I made 30% in 6 months. This seems too good to be true. Let me book my profits.

  5. I lost 30% in 6 months. This is all a scam. The stock market is rigged.

All of these thoughts are the result of not understanding what you are doing and not having a well-researched strategy that you have conviction in.

Good investors do the thinking beforehand and have a strategy that they believe in. They don't do something just because everyone else is doing it. Hence they are not saddled with these questions after they start investing.

How to become a good investor?

1. Know what you are doing. Have a plan.

Do your homework.

Don't start investing in Mutual Funds just because all your friends are or because of TV commercials.

First understand what it is all about. You can read our beginner's guide to investing here.

Stock markets have always moved up and down. Just because you have started investing now, it's not going to go up in a straight line.

Also, I don't know of any stock market or Equity Mutual Fund investor who has never been in loss.

Zero (including myself).

If you have not yet seen a loss, you will at some point. Be ready for it.

2. Know yourself.

It is not mandatory for everyone to invest in stocks or Mutual Funds. Some people have very low risk tolerance and they are better off sticking to their savings account or FDs.

Do what makes you sleep easy at night.

Of course the best scenario is to educate yourself so that you can sleep easy with some of your money invested in Mutual Funds or stock markets, but till the time you can't, don't invest too much.

If you don't know your risk profile, take this risk profile questionnaire. Don't try to game it. Just be honest. After that see if your current investments are in sync with your risk profile. If not, that's a recipe for investment failure.

3. Use the right benchmark.

The right benchmark for you is not Nifty or Sensex or some total returns index or anything fancy.

These are benchmarks for Mutual Funds, not you.

In the long run, your investment outcomes will have less to do with the Mutual Funds you are investing in than with your own investing behaviour and discipline.

So how do you keep track of your behaviour?

Simply by measuring how well you are sticking to your own plans.

(Don't have a plan? See point 1.)

You were supposed to save and invest 30% of your salary every month. Have you been doing that?

Did you set up a SIP initially but are now trying to time the markets by doing ad-hoc lumpsums?

Are your goals on track?

Even if you don't get the expected results initially, you should count it as a win every time you follow the plan.

Count it as a win every time you save the amount you planned to save (and a loss if you don't).

Count it as a win every time you pay for your SIP (and a loss if you don't).

Ignore external benchmarks. Follow your own.

Do these three things and you will be in the top 5% of investors (or poker players).

Ignore these and even the best Mutual Funds will be of no use to you.

Ping us on chat if you want us to evaluate your current investments or plans. We'll be happy to help.