Five Bad Reasons To Invest The Way You Do

This past month I taught an adult education course on investing. I began the first session with a discussion of the following question: “What are we really trying to do when we invest?”

I’ll conclude this column with what I think we should try to do when we invest, but I can think of at least six common goals that can get in the way of that should.

Seem Smart/Competent

Many of us approach investing as another area for standing out as smart, or for proving our special competence.

Doctors for example – highly competent and smart in their own specialized field – might figure they know which health-care or pharmaceutical stocks to buy.

A marketing executive might see broad societal trends in the fashion world, or a chemistry professor could apply his knowledge to pick small bio-technology  stocks.

When you listen to a group of guys (for some reason it’s usually guys) discussing their individual stock picks, that ‘proving competence’ thing is what’s going on.

Conform

Just as common as the need to ‘stand out’ from the crowd – in fact, probably more common – is the instinct to do exactly what others are doing, to conform. This isn’t necessarily a bad thing under ordinary scenarios.

For an endowment that I help manage, an instinct for conformity can be a very positive thing, because it forces our investment committee to figure out what similarly situated endowments are doing. If we decide to deviate from the crowd, at least we’ll have the chance to think about why we’re doing so.

On the negative side, however, conformity is how we may end up participating in – and suffering from – financial bubbles or financial fads without particularly meaning to. The ‘wisdom’ of the crowd sometimes goes terribly wrong.

Gambling Rush

Let’s face it: Gambling is fun. Winning a financial bet, especially a bet on a stock that moves in a short-term way as predicted, is right up there as one of life’s great adrenaline rushes. I just bought that stock and boom! it jumped 15% in a week! I am a Golden God!