An Overlooked Psychological Factor Critical to Investment Success

By Tom Madell, Publisher and Editor of Mutual Fund Trends and Research
Dec. 6, 2002

Most investors fail to realize that their own inner psychology and biases are a major factor in how successful or unsuccessful they will be.

People rarely make investment decisions based solely on relatively objective information such as fund data, the direction of the economy, etc. Rather, we "interpret" and even change the conclusions that might be drawn from such information in our own subjective ways, based on our particular assumptions, biases, experiences, emotions, and even personalities. The result is that each investor's own psychological makeup can become one of the utmost determinants of their investment decisions, more important even than any factual data they are considering. I have frequently discussed some of these psychological components to successful investing on my web site at funds-newsletter.com.

The characteristics of flexibility and open-mindedness can be among the most important attributes contributing to investor success. If you can acquire these characteristics, you will be open to new input and not locked into views that may have become no longer valid, or perhaps were not well-founded to begin with. You will be able to appropriately alter your investment strategy when faced with new data, the perpetually changing investment landscape, and your own ever-changing interpretations of events. You will also remain open to a spectrum of opinion from others, rather than tending to sub-consciously trivialize such input before even fully hearing it. In other words, you will allow yourself to always be attuned to the possibility of new ways to achieve your investment objectives, rather than attempting to constantly stick with one "set" formula.

The opposite of flexibility and open-mindedness is demonstrated by people who have "pre-formed" opinions. As a result, they are not truly open to embracing new information, learning from their own missteps, and profitting from the knowledge afforded to them by others. Such characteristics can lead to you to over-rely to what has worked in the past - a sure recipe for underperformance in times when investment prospects are frequently in flux.

For example, although the "facts" favor stocks over bonds for long-term investors, many investors have steadfastly refused to even consider bonds despite the fact that bonds have at times outperformed stocks for periods of five, 10 or even 15 years running, including just recently, as we reported in mid-October.

Unfortunately, in my experience, far too many mutual funds investors appear to have a closed mind when it comes to their investing. In particular, they would prefer to go by yesterday's trends and not put much effort into their investing once they have made their initial purchase decisions.

Investing generally is not an activity subject to an unchanging set of rules. And so investors who are open to a variety of inputs and strategies often do better than those who think that a single strategy or even a single category of investments will always work out favorably in the end.