Is it hard to control your emotions?
The toughest part about being a good investor is conquering your own mind and even more specifically, your own emotions. Most of us can learn the technical aspects required to calculate intrinsic values, assuming we have the interest. But our mind is both our biggest asset and our greatest liability. The emotions we experience in relation to our money are often very intense and counter productive, persuading us to react in precisely the wrong way.
Warren Buffett said: “Intrinsic value is the number, that if you were all knowing about the future and you could predict all the cash a business would give you between now and judgement day, discounted at the proper discount rate, that number is what the intrinsic value of the business is. In other words, the only reason for making an investment and laying out money now is to get back more money later on. That’s what investing is all about. When you look at a bond it’s very easy to tell what you get back, it says it right on the bond, it says when you get the interest payments and the principal. The cashflows are printed on the bond, the cash flows aren’t printed on the stock certificate. That’s the job of the analyst, to change that stock certificate, to change that into a bond. To say that’s what I think it will pay out in the future.”
The math required to calculate the intrinsic value of a stock is arguably very straight forward. You can find any number of business math books and websites that can describe this for you, along with an ever-growing number of videos that will show you how to do these calculations and even how to set up a spreadsheet to do it for you, quickly and accurately.
The accounting knowledge required to calculate intrinsic values is a little bit more difficult but still very learnable by most who have the interest to do so.
Then of course there is the business acumen required to intelligently make assessments and judgments about how to use all the information you learned about a company, it’s industry and its finances. While I believe this step is more challenging than the prior two technical skills, it is still learnable with plenty of interest, reading and practice.
But far and away the most difficult challenge for you as an investor is to master your own emotions. Without mastering the skill of controlling your emotions, you will end up getting too excited when your investments go up in value, and too depressed or angry when they go down.
I tell you this now because it is a massively important skill for your investment success. It will take a lot of consistent effort on your part to master, along with some the needed practical experience before you can master the control over your emotions needed to become a good investor.
How can learning about intrinsic values help me control my emotions and improve my investing?
Truly understanding the concept of intrinsic values is, I believe, the best way to help you control your emotions when it comes to investing. I know that doesn’t surprise you. I will give you some context to think about.
Picture making two investments of $5,000 in each one. The first investment is from something along the lines of a stock tip from someone you know or that you heard talked about on social media. The investment sounds really exciting and everyone seems to be making money as the stock continues to rise week after week. The second one is a company that you have been studying and learning about for weeks and now that you believe you understand the company and its industry quite well you make an assessment of it’s intrinsic value. Since the current market price is comfortably lower than your assessment of the intrinsic value you decide to buy it, for the long term.
At some point in the future these stocks experience a decline of over 30%. Yup, 30%! How will you be feeling about each one of these investments at this point?
Think about that for a moment. Whatever the value was before the drop, your portfolio is now down 30% from there. And maybe the drop comes not long after you made the investments so your $10,000 is now worth $7,000. Virtually all stocks will experience something like this eventually so start getting prepared. And before you think you can avoid this scenario, let me tell you right now that you can’t.
How does this drop in market value make you feel about each of these investments? Do you feel the same about both? Are you fearful? Will you shrug it off and hold on? Do you regret buying either of them? Will you sell one, or maybe both? Will you buy more of either one?
The way you answer those questions largely depends on how well you understand your investments, your level of confidence in your understanding of your investments and their long-term intrinsic value.
The importance of having a strong understanding about your investments comes to light when their market prices fall, and not in while they rise.
Closing thoughts
We will touch on this topic frequently in our musings because our emotions have a huge influence on how we behave. Being in control of our emotions will make a big difference on our investment returns as well as our overall investment experience.
And while you may still make a fair return if you don’t learn to control your emotions, you will likely become manic depressive. That’s not an exaggeration. Then you will be the person they talk about in the headlines, feeling great on the days when the market is up and lousy on the days the market is down. For those who have experienced this or something similar, you know full well, that’s no way to go through life.
Having more wealth should help make your life better and getting wealthier should to.
Until next time.
Invest wisely. Live well. Be someone’s hero.
Lars Borghardt
