Five Bad Reasons To Invest The Way You Do

CoolerThis 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.[1]

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!

Even losing, as gambling addicts eventually acknowledge, offers a perverse, dark, thrill. Lady Luck, she hates me! Secretly, I know I deserve this shameful loss. (full disclosure: I ate that third Krispy Kreme at 1am when everyone else was asleep). I am a loser, but I rolled the dice and took my chances. I suffered and lost but it feels good to be alive!

Sands Casino Chip

Anyway, I digress, but none of this adrenaline rush from gambling is helpful.

Get Rich Quick

There is no way to get rich quickly from investing.

Wait, let me correct that. There is no reliable way to get rich quickly from investing. There are quite a few unreliable ways.

Anyone can, conceivably, flip a coin and receive heads five times in a row. Heck, that will happen 3.125 percent of the time you flip a coin five times in a row. So, some small amount of people will get rich quickly from an unreliable approach. I wouldn’t recommend any of those ways.

The more you are in a hurry to get rich quickly through investing, the more you will end up flipping tails over heads, right into a financial ditch on the side of the road. (And that, my friends, is the way to mix metaphors. Like a boss.)

Maintain a relationship

This is probably the most hidden yet pervasive reason people make sub-optimal choices with their investments.

“My Dad used to invest with this guy,” or “Everybody at my church follows this person’s advice,” or “I’d feel bad taking my investment account away from my neighbor.”

That’s all fine, as long as you don’t mind paying tens of thousands of dollars – probably more if you have a sizeable portfolio or a long time horizon – to avoid a stressful 5-minute conversation. Hey, that’s cool, it’s your money.

We’ve all done this

Even while criticizing these reasons many people invest, I should point out what I hope is obvious:  I have done all of these things. They are common and natural and I understand. But also, these are all errors. If you’re investing to look smart, to fit in, to satisfy a gambling urge, to get rich quickly, or to avoid straining a personal relationship, over time you’ll probably pay quite a bit for these choices.

So…what is a good reason to invest?

The best I’ve come up with so far is this:

We should invest so that over time (5 years at least), we can grow our money to generate enough passive income to cover our lifestyle costs when we stop working.

That seems simple enough. But in fact there’s a lot of stuff packed into that sentence, having to do with the meaning of words like ‘grow’ and ‘passive income’ and ‘lifestyle costs.’ I’ll unpack those later.

For the moment, however, it’s worth examining which of the above five bad reasons dominate your investing approach, and whether you can afford the many thousands of dollars this will cost you over your lifetime.

 

[1] Forgive me, family members and good friends (you know who you are), for sounding a skeptical note on your stock-picking abilities.

 

A version of this ran in the San Antonio Express News

 

See related post:

How to Invest – I finally give the answers

 

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I founded Bankers Anonymous because, as a recovering banker, I believe that the gap between the financial world as I know it and the public discourse about finance is more than just a problem for a family trying to balance their checkbook, or politicians trying to score points over next year’s budget – it is a weakness of our civil society. For reals. It’s also really fun for me.

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