The key to smart investing? Tame your emotions.
28 May 2024Last Updated:28 May 2024
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In this edition of Investing chronicles, Lockstep CEO Paul Farah shares how to prevent emotions and unrealistic expectations from clouding your investment decisions.

Last week, we discussed the journey we’re embarking on – searching for high-quality businesses where others aren’t looking. We laid out a set of principles to guide us. If you missed last week’s newsletter, here’s 5 fundamental principles for better stock analysis. There will be exceptions to these principles, but sticking to these five guidelines will greatly increase our chances of long-term success.

But before we can begin, we need to discuss an essential aspect of investing: managing your emotions when investing.

“Individuals who cannot master their emotions are ill-suited to profit from the investment process.”
Benjamin Graham

Investing is difficult because it involves our hard-earned money, and when it comes to our money, we’re naturally emotionally involved. It is, therefore, imperative as investors to be aware of this and not allow these emotions to influence our decisions because this is a recipe for disaster.

One tool we have at our disposal is managing our expectations.

My experience has taught me that emotions overtake our decision-making when our expectations are out of line with reality. It is akin to an amateur golfer who starts his round of golf with the expectation of playing as well as the professionals he watched on TV the night before. It is almost guaranteed to be a bad round of golf, leaving the golfer frustrated.

Let’s not be that way when we invest! Instead, let’s set some expectations for investing before we even begin.

1. Finding exceptional companies is challenging

If it were easy to find exceptional companies, everyone would do it. If everyone were doing it, these exceptional companies would all be valued at fair market prices, making our efforts futile.

So our first expectation is that it won’t be easy to find extremely high-quality businesses that we can hopefully hold for the rest of our lives. My goal is to find 10 such companies; for now, I believe I’ve discovered two after two years of searching. The point is that we won’t find these companies overnight, so we need to be patient.

2. Long-term potential takes time to unfold

Just because we’ve found great businesses doesn’t mean we should expect immediate rewards.

Take the St. Joe Company (JOE), which I discussed in Economic moat company examples. JOE’s value lies in its land, which sits at cost on its balance sheet. This land was purchased decades ago, so we know it’s significantly undervalued. Only once the land is developed will this value be unlocked.

The company owns 168 000 acres, so developing this land will take decades. I, therefore, expect that JOE will take many years to reach its potential. If I went into this investment expecting the market to realise the company’s true value overnight, I would get frustrated quickly.

3. We won’t be right all the time

Even legendary investors like Warren Buffett have made most of their wealth from just a handful of companies. Since we strive for similar success as the maestro, we must acknowledge then that he has made numerous investments that didn’t work out.

Mohnish Pabrai, one of Buffett’s disciples, aims for a 60% success rate; I’d be happy with 50%. Setting this expectation prevents us from putting all our eggs in one basket or taking too large a position in just one stock.

Fortunately, if we find quality businesses that can compound in value, then being right 50% of the time means we can still make a lot of money.

4. You will be wrong

Expecting not to be right all the time prevents us from being overly aggressive when we buy into a company. Expecting to be wrong keeps us humble after we invest.

Even if we find what we believe to be outstanding businesses, we will make mistakes. Expecting to make mistakes helps us remain honest and humble so that we can acknowledge our mistakes.

It’s not easy to spend 40+ hours researching a company only to uncover information that disqualifies it as an investment – the instinct would be to dismiss this information and proceed. It’s even harder to research a business for 80+ hours, invest in it, and monitor it for six months, only to see your investment thesis fail to materialise.

You have to be able to let go when you realise your mistakes because if you fail to admit when you are wrong, you can lose a lot of money.

5. Invest only what you don’t need

To manage our expectations it is essential, in my opinion, that you are in a position to invest for the long term.

There is no point in using your savings to invest in 10 exceptional businesses if you need those savings to fund your life. You will constantly have to sell without benefitting from the long-term compounding. It is also pointless to invest the money if you need it a year or two later to buy a house, a car, or whatever you are saving for.

Equally important is not to invest everything you have to the point that you can’t sleep at night when your portfolio loses 10%, 20%, or even 30%.

The ideal scenario is investing money that you can almost forget about, allowing it to compound year after year, rather than anxiously watching every up and down tick of the share price.

Closing thoughts

Investing isn’t easy because it involves our hard-earned money, resulting in us making decisions based on emotions.

But if we invest only money that we are happy to leave for the next 10, 20, or 30+ years and ensure our expectations align with an investing reality, in that case, it will be far easier for us to control our emotions and, therefore, succeed.

So remember:

Invest only what you don’t need: Ensure you can afford to leave your investments to grow over the long term without needing to sell prematurely.

Be patient in your search for exceptional businesses: Recognise that finding high-quality companies takes time.

Be patient while waiting for a business’s value to be unlocked: Understand that it may take years for a company’s true value to be realised.

Expect to be right only some of the time: Accept that not all investments will be successful.

Expect to be wrong, so don’t lose money when you are: Acknowledge mistakes and adjust your strategy to minimise losses.

There’s plenty more to discover with Lockstep. 
Head over to Lockstep to subscribe to Paul Farah’s weekly investing newsletter. It’s never been easier to gain valuable insights that you can apply to your investment journey and take your money game global.

* Paul Farah has worked in financial markets since 2006, holding positions at prestigious firms from New York to South Africa. Now, he manages his own money and provides access to his entire portfolio through his company Lockstep Investing. The views and opinions shared are his own and are for informational purposes only, it is not intended to serve as investment advice and it does not represent the view or opinion of Standard Bank. This information should be used as a starting point for generating investment ideas, and should not be relied upon as the sole basis for making investment decisions. Lockstep Investing (PTY) LTD and the Standard Bank of South Africa Limited will not be responsible for the results of any investment decisions made based on the views provided. 

Learn five tips to manage expectations and invest smarter.
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