“Doing well with money isn’t necessarily about what you know. It’s about how you behave. And behavior is hard to teach, even to really smart people.” ~ Morgan Housel, The Psychology of Money
Individuals must understand that there is a psychological mindset that the successful investor tends to have.
The successful investor will focus on probabilities, intrinsic values and safety of margin while letting decisions be ruled by rational, as opposed to emotional, thinking.
Investors’ emotions are their worst enemy.
The psychology of money is the study of our behavior with money. Billionaire investor Warren Buffett contends that the key to overcoming emotions is being able to retain your belief in the fundamentals of the business, and not get too concerned about the stock market price.
Investors should realize that there is a certain psychological mindset that they should have if they want to be successful, and try to implement that mindset. Dave Ramsey has said that building wealth is “20% head knowledge and 80% behavior.”
Value investing mindset
Value investing derives the intrinsic value of a common stock independent of its market price. By using a company’s factors such as its free cash flow, earnings, return on invested capital, and dividend payouts, the intrinsic value of a stock can be found and compared to its market value. If the intrinsic value is more than the current price, the investor should buy and hold until a mean reversion occurs.
Mean reversion is the theory that over time, the market price and intrinsic price will converge towards each other until the stock price reflects its true value. By buying an undervalued stock, the investor is, in effect, paying less for it and should sell when the price is trading at its intrinsic worth. This effect of price convergence is only bound to happen in an efficient market.
The fundamental principle of value investments lies in the ability of the markets to eventually correct to their intrinsic values. Common stocks are not going to remain inflated or bottomed-out forever despite the emotions and irrationality of investors in the market.
"Savings can be created by spending less.
You can spend less if you desire less.
And you will desire less if you care less about what others think of you.
Money relies more on psychology than
finance."– The Psychology Of Money
— The Psychology Of Money (@Psy_of_Money) January 27, 2022
References:
- https://www.investopedia.com/terms/b/bengraham.asp
- Morgan Housel, The Psychology of Money. Harriman House, Great Britain, September 8, 2020.
- https://www.amazon.com/gp/product/0857197681/ref=as_li_tl_nodl?