Ways to Reduce Temptation

10/31/2011 11:30 am EST

Focus: MARKETS

Danielle Park

President and Portfolio Manager, Venable Park Investment Counsel, Inc.

Danielle Park, author of Juggling Dynamite, explores why it’s so easy to let emotions dominate your investing decisions, and shares a couple of easy tips to reduce the temptation in this exclusive interview with MoneyShow.com.

Danielle, give us some ideas about how investors with different objectives can tailor a strategy that makes sense for them.

Yeah, it’s interesting. I think that most people, in truth, have about the same strategy or the actual same goal. I know there’s a lot of talk about, you know, depending on your age or your stage, you should have a different long-term focus, or short-term focus.

What I’ve found is that humans are pretty much all the same when they start to face, for example, losses. Everybody who maybe intended to be a long-term investor, if they start to see significant declines in their portfolio, they become much more short-term focused, right?

I like to say it’s actually a fallacy that humans can be these sort of objective robots that will just put money in and not look at it for 20 years. The reality is that we tend to look at our statements daily, weekly, monthly, right? So we’re not really cut out for the long-term thesis, we’re more very much in tune in with what’s happening with this month, these six months, these 12 months.

That makes the job of investing for any kind of long-term horizon pretty tricky in the short term, because what I find is people tend to react badly and then sell at the wrong time, for example. So to confront that or to assist with that real-life dynamic, I think that you have to try and anticipate cycles.

So let’s talk about market cycles. The economy basically expands for a certain period of years, and then contracts, and then during those bear markets, that’s when the stock market can lose 25% to 50% of its value. It’s avoiding those parts that we really have to focus everything that we do.

Most people focus all of their energy on trying to be in for upside, and they forget about this really significant part of the contraction phase, which is part of every business cycle. So as a result, everything that we do has to be about keeping that snowball together…as we’re rolling our snowball across, not letting something come in and smash a big corner off of it.

So whether you’re 20, or 40, or 70, I don’t think you can afford to lose a chunk of your ball. You have to always think about capital preservation first.

In fact, what’s ironic is, I find the financial industry is always talking about if you’re wealthy, you have a high risk tolerance. I find that to be the opposite of my experience.

People with quite a bit of money have a lot of lose, and in my experience, they tend to be very risk-averse. They’re the ones who want out if things start to go south. They don’t want to leave their capital exposed to a large portion of volatility, for example.

So a lot of people that are sort of riding the train and trying to double down are the people who have very little money…and that actually brings us to another big risk in the marketplace. If people who are participating have very little to lose, and are doing it on leverage and margin, it makes for an extremely volatile dangerous marketplace because they tend to be reckless risk-takers.

They’re trying to sort of gamble for the house. When they lose, they blow up, but they’re little so nobody really notices. Whereas the big funds in the world are driven by more conservative asset allocators.

Let me wrap up today just by asking you some quick tips for managing some of these emotional components of investing.

Well, first of all, allocation is incredibly important. You shouldn’t have all of your money in the stock market, ever, in my experience.

You should have a good component of it in high-quality bonds. To which people will say, "Oh, bonds are overdone." Well, in flight-to-safety times like we’ve seen in the last couple of years, during these intense acute phases in the world financial crisis, the big money goes back to rest in things like US Treasuries…and we’ve seen that in spades in the last couple of months.

So you need to have a good part of your money in the highest-quality credits you can find. You need to have cash at points in the cycle. Because if you don’t ever sell, you can never get the buying opportunities that come in the downturns.

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