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The Psychology
of Money
T
he study of what makes us all tick is endlessly fascinating. It is es-
pecially intriguing to me that it plays such a strong role in invest-
ing, a world that people generally perceive to be dominated by cold
numbers and soulless data. When it comes to investment decisions, our
behavior is sometimes erratic,
often contradictory, and occasionally
goofy. Sometimes our illogical decisions are consistently illogical, and
sometimes no pattern is discernible. We make good decisions for inex-
plicable reasons, and bad decisions for no good reason at all.
What is particularly alarming, and what all investors need to grasp,
is that they are often unaware of their bad decisions. To fully under-
stand the markets and investing, we have to understand our own irra-
tionalities. That is every bit as valuable to an investor as being able to
analyze a balance sheet and income statement.
It is a complex,
puzzling, intriguing study. Few aspects of human
existence are more emotion-laden than our relationship to money. And
the two emotions that drive decisions most profoundly are fear and
greed. Motivated by fear or greed, or both, investors frequently buy or
sell stocks at foolish prices, far above or below a company’s intrinsic
value. To say this another way, investor sentiment has a more pro-
nounced impact on stock prices than a company’s fundamentals.
Much of what drives people’s decisions
about stock purchases can
be explained only by principles of human behavior. And since the
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T H E W A R R E N B U F F E T T W AY
market is, by def inition, the collective decisions made by all stock pur-
chasers, it is not an exaggeration to say that psychological forces push
and pull the entire market.
Anyone who hopes to participate profitably in the market, therefore,
must allow for the impact of emotion. It is a two-sided issue:
keeping
your own emotional profile under control as much as possible and being
alert for those times when other investors’ emotion-driven decisions
present you with a golden opportunity.
The first step in properly weighting the impact of emotion in in-
vesting is understanding it. Fortunately, there is good information at
hand. In recent years, psychologists have turned their attention to how
established principles of human behavior
play out when the dynamic is
money. This blending of economics and psychology is known as behav-
ioral finance, and it is just now moving down from the universities’
ivory towers to become part of the informed conversation among invest-
ment professionals—who, if they look over their shoulders, will f ind the
shadow of a smiling Ben Graham.
T H E T E M P E R A M E N T O F A T R U E I N V E S T O R
Ben Graham, as we know, f iercely urged his students to learn the basic
difference between an investor and a speculator. The speculator, he said,
tries to anticipate
and prof it from price changes; the investor seeks only
to acquire companies at reasonable prices. Then he explained further:
The successful investor is often the person who has achieved a certain
temperament—calm, patient, rational. Speculators have the opposite
temperament: anxious, impatient, irrational. Their worst enemy is not
Success in investing doesn’t correlate with IQ once you’re
above the level of 125. Once you have ordinary intelligence,
what you need is the temperament to control the urges that
get other people into trouble in investing.
1
W
ARREN
B
UFFETT
, 1999
T h e P s y c h o l o g y o f M o n e y
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the
stock market, but themselves. They may well have superior abilities
in mathematics, f inance, and accounting, but if they cannot master
their emotions, they are ill suited to prof it from the investment process.
Graham understood the emotional quicksand of the market as well
as
any modern psychologist, maybe better. His notion that true in-
vestors can be recognized by their temperament as well as by their skills
holds as true today as when f irst expressed.
Investors have the following characteristics:
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