The Mind Game of Investing

02/15/2012 9:15 am EST

Focus: MARKETS

The old saw goes that baseball is 90% mental, and the same can be said of investing. If you keep the right frame of mind, it can help you make more of the right decisions in challenging circumstances, writes Farnoosh Torabi of Psych Yourself Rich, excerpted in Investor’s Digest of Canada.

My mom has a short, pithy philosophy when it comes to taking risks: “You’ll never know your true potential unless you get out of your comfort zone.”

My mom and the brainy folks at Google (GOOG) think alike. Engineers at the search giant dedicate 20% of their time, or one day a week, to pursuing projects that take them down a whole new path.

Google, which calls its philosophy “innovative time off” or “20% time,” boasts that the initiative has led to major corporate product launches from Gmail to AdSense. In all, the company estimates about half its new products launched in the last six months of 2005 stemmed from this emphasis to be “creative” at work.

So, how does this apply to investing?

It basically means embracing the unconventional. Of course, investing is still a sore spot for many Americans as they climb out of the recession—and understandably so. Many of their 401k portfolios got sliced in half, earning a new name: the 201k.

Listen to Curtis Faith, a successful US entrepreneur and best-selling author of Trading From Your Gut and Way of the Turtle. He’ll tell you that a strategy of buy and hold, where you put X amount of money in stocks, bonds, and funds and ride out the market until retirement is no longer the best way to manage risk.

Instead, investors need to be willing to shift their allocations periodically to address the risks in the marketplace, while addressing their own personal needs.

If you want to beat the curve, you need to review your investments once a month. If, for example, you’re heavily invested in stocks and see that the S&P 500 keeps bouncing around a high level, say, 1,500 (as it did in late 2008 before the market crashed), here’s what you should do.

You should manage risk by adjusting away from high-risk investments to lower-risk instruments, such as cash and bonds. This is very important if you know you’ll need the cash currently tied up in shares for something critical over the next five years.

When you’re examining your portfolio each month, pay attention as well to the long-term cycles. This might be a lot to ask, since Americans tend to analyze short-term patterns, as some behavioral economists have concluded. But as Curtis notes, you should never be caught by surprise if you pay attention to historical trends.

“It was apparent to anyone who was paying attention to the real estate market that the rise was unsustainable,” notes Curtis, of the subprime meltdown that pushed the US into recession. “What’s more,” he adds, “lots of people were talking about it.” So, read the newspaper and talk to older investors who can give you their perspective on trends.

Finally, to manage risk, you have to be willing to lose (at least a little). “Any time you make a financial decision around uncertainty, you have to be willing to be wrong,” Curtis points out.

For example, you might see the trend reports on real estate and deduce that the gains cannot be sustained for much longer. So, you sell your condo and, for the next year or two, prices continue to go up. You feel like an utter loser. You have seller’s remorse.

That’s a risk you might need to take. But in the long run, it should pay off. In other words, it’s perfectly OK to leave the party early. “When you deal with uncertain outcomes, the right decision doesn’t always result the way you expected it,” Curtis says.

Warren Buffett famously said that a key to investing well is to “be greedy when others are fearful.” He’s right. Opportunities present themselves when people are running for the hills.

This signals a great time to consider alternative paths. Don’t fear being contrary. “A lot of major successful companies started during times of great stress, recession and depression,” says Victoria Colligan, founder of Ladies Who Launch.

She’s not surprised by the rising trend in female entrepreneurship during the recession. And she wasn’t surprised at all by the movement, referencing the Great Depression of the 1930s as an example of how individuals can embark on once-in-a-lifetime opportunities in down times. Indeed, Colligan notes, several blue chip companies, such as Hewlett-Packard (HPQ), got their start during the depression.

For some, breaking from the norm in hard times has to do with the “what-do-I-have-to-lose” mentality, a mentality that can actually encourage people to take a chance. For others, a recession or depression presents fewer barriers to entry, such as a bigger talent pool, cheaper real estate and technology, not to mention more flexible ways of doing business.

Aside from starting a business, consumers in the latest recession snatched up deals—from homes at heavily discounted prices to beaten-down stocks that should one day provide a more secure retirement.

In fact, if you bought any of the depressed financial stocks at the depth of the recession, you probably ended up making a tidy profit less than a year later. To break free from the norm is to get out of your comfort zone and open yourself up to a bigger world of opportunity in your personal, financial, and professional life.

If we can commit to creativity, at least once a week as the folks out at Google reportedly do, we have a great chance of accomplishing our furthest, dear-to-our-heart goals—in good times and bad.

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