Achieving great returns and beating the market gives us a feeling of pride. Pride usually goes hand in hand with confidence. The combination of the two is what Buffett refers to as the 'Cinderella' feeling.
"The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball.” – Warren Buffett
There is no trouble with having trust in your investment capabilities; it's perfectly natural. Although, confidence does turn problematic when investors become over-confident. Over-confidence is a bad personality trait for investors as it can easily derail investment results. Unfortunately, most investors are too confident in their capabilities to pick market-beating stocks.
Over-confidence Can Harm Your Portfolio
Over-confidence is a common phenomenon in the investment world. It is difficult to retain a sense of objectivity, especially when your portfolio is performing well. Most of us share the goal of ‘beating the market’, and if we succeed in doing so, we receive a sudden boost of confidence. Self-assurance in your investment capabilities is needed, but it might put your portfolio at risk if you don’t know how to contain it.
“Behaving Badly,” a study done by James Montier in 2006, surveyed 300 professional mutual fund managers. As expected, 3 out of 4 of them thought they were better than average at their jobs, where in fact only 50 percent of them can, by definition, be above average. Likewise, the average investor thinks they’re smarter than the average investor.
Through the eyes of an over-confident investor, market gains are the direct effect of their smart decisions while their losses are due to bad luck. Unfortunately, in the majority of cases the opposite occurs. In reality, gains are mostly attributed to luck while losses are the direct result of bad decision-making.
A bull market contributes to this mentality. Many bad decisions are made and saved by the upwards trend of the market. Those poor decisions will become clear when the market turns, and could ruin your portfolio.
Take Control of Your Emotions
Investors like thinking that they are the next Warren Buffett. You might be doing well, but you will only be able to tell whether it is the result of skill or luck after you have been trading for as long as Warren Buffet. You can’t compare yourself to the Oracle of Omaha after only trading for a few years.
If you do achieve the same success, you can give yourself a pat on the back for keeping composure and not being over-confident. Buffett certainly didn't achieve his wealth by making overly confident and risky decisions (read some handy Warren Buffett facts here). The only way to attain the same amount of success is to take control of your emotions and not allow them to get the better of you.
Let’s face it, only a select group of people are born with a temperament similar to that of Warren Buffett. The best way to turn a bad personality trait into market-beating success is to:
- Choose an investment strategy
- Stick to it
- Make use of tools that support your strategy
- Switch off your emotions
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- No more emotion-based decisions
It is important that the tool targets the best investment opportunities in real time. These targets are based on objective financial data. You can’t disagree with cold hard facts, which makes it easier for you to buy, hold or sell stocks at optimal times, guaranteeing great returns with low volatility. Emotions are taken out of the equation, so whether you feel over-confident or under-confident you can be assured that you will make the best choices by using such a value investing tool.
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