When I started investing money, I received some truly great advice. I was speaking with a successful investment manager, who said: “Know your money personality, and try to minimize losses.” I’ve received plenty of bad advice over the years, and at the time (I was in my teens), I thought his words seemed cheesy and trite. I didn’t realize until later how important his advice was. Here’s why:
A chapter in the book What I Learned Losing a Million Dollars sums it up succinctly. Author Jim Paul, a former trader who lost millions on failed commodities and stock bets, says, in sum, the following: All things involve risk for the simple reason that the future is uncertain—never being fully revealed to us. Hope and fear—our strongest reactions to the uncertain future—many times force us into reacting to present conditions emotionally.
Emotionality is why most investors do not do well if left to do it themselves. Since we don’t live in a certain, riskless world, we need a way to deal with the uncertain future. When dealing with the risk that uncertainty produces, we have three ways, or three personality types, to handle our choices (this is particularly true of investments). We can be an:
Know Your Money Personality
The engineer will seek to know everything necessary to produce a technically logical answer to the problem of risk. The engineer will build safety margins into their calculations to eliminate risk on the fringes of the uncertainty curve. Therefore, the engineer lives in a world of “certainty” because they strive to control most, if not all, of the variables that affect the outcome.
The gambler, on the other hand, knows nothing about the outcome of their bets; nor does the gambler care. The gambler seeks only the thrill of winning or guessing right (or wrong). Gamblers, opposite engineers, live in a world of “uncertainty.” People often take pride in seeing themselves as gamblers, viewing the size of their bets as a mark of bravado and being able to brag about winnings should they occur. Even losses for a gambler can be prideful scars that they see as enabling them to power through the losses and achieve success.
Lastly, we have the speculator. A speculator takes what they think is all the relevant information and tries to build an assumption about the direction an investment will take (up, down, or sideways). Speculators are different from engineers in that they realize they don’t and can’t know all there is to know about the risks—but they invest anyway. Speculating is the application of intellectual and systematic analysis to the problem of the uncertain future. It’s a far more logical approach than the gambler but less exacting than the engineer.
Why is this important?
Most people’s personalities combine all three traits, but also tilt strongly in one direction or another. We’re all familiar with our inner biases, and I believe that understanding these three types of investing or money personalities can help keep us from getting into trouble.
Building Safeguards into Your Financial Decisions
Knowing our money personalities is important so that we can determine our limits and build safeguards into our behaviors when making financial decisions. These limits must be decided while we’re not undergoing stress and then be applied rigorously. For example, I had a business trip that took me to Las Vegas last year. I set a loss limit of $100 playing blackjack. I knew that if I started to win, I’d think linearly and keep playing until my winnings turned into losses.
So, I determined, while sitting in my hotel room, I’d take my winnings after an hour of playing and, if I doubled my money, go have a nice dinner on the house. If I lost, I’d stop at $100, enjoy my free cocktails at the table, and dine on a less expensive bean burrito later.
We can and should apply the same limits to our investing lives. Using another example, if you’re concerned about your investment returns, set a time and dollar loss limit for either implementing another strategy that has been time tested or turning your investments over to a professional. For instance, a limit might entail the following statement: “If I don’t meet or beat a particular index over several years, or sustain outsized losses, against a benchmark, then I’ll fire myself and hire a professional.”
I’ve viewed many prospective clients’ portfolios, and even in the face of large, consistent losses or excessively volatile swings, they refused to seek professional help because they never took the time to think through their money personalities and set some realistic limits.
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