Every investor has a deep desire to beat the market. It is ingrained in human nature.

In a 1988 speech, Charlie Ellis* explained: “There are three ways in which you might try to achieve superior results: one is physically difficult, one is intellectually difficult, and one is emotionally difficult.”

He suggests 3 different paths to surpass the average:

1. Outworking: Investing substantial effort,
2. Outsmarting: Employing intellectual acumen, or
3. Out-behaving: Exercising emotional discipline.

He concludes: “Being incapable of the intellectually difficult, and reluctant about the physically difficult, I have set about the emotionally difficult approach to investing”.

The challenge with investing is that we need to make decisions based on incomplete information about the future. We do not know in advance what will happen, and no one can predict the future with any consistency.

Research also doesn’t observe rational behaviour in investors, especially at market extremes. Emotional impulses triggered by stress clouds human judgment, leading to suboptimal decisions that compromise long-term outcomes.

Mastering good investor behaviour in financial markets requires self-awareness and intention. The seduction of outsmarting the market unfortunately persists. The path to outperformance however lies not in attempting to outwit the market, but through better behaviour.

Controlling one’s behaviour and responses to market fluctuations empowers you to regulate your inner world more effectively. Establishing a long-term feasible strategy aligned with your individual objectives and adhering to it is paramount. The often-overlooked commitment of then holding onto this strategy through market and economic volatility proves to be the most challenging yet rewarding aspect.

You cannot control the volatility of the markets, but you can control your response to it.

Embracing the emotionally challenging approach to investing offers the highest probability of outperforming the average over time. Prioritizing the fulfilment of personal future objectives serves as a more meaningful benchmark than merely outpacing relative averages.

It is not adverse market conditions or flawed plans that lead investors astray. It is  their behaviour.

Prefer a strategy where you have an advantage. Knowing yourself and regulating your behaviour is such an advantage. Behavioural alpha is the one factor that is within your control.

If you cannot manage how you respond to your emotions in the investment markets you will struggle to be successful, however you define success.

You just need to behave better than the average investor.

 

The above article was written and adapted by Marius Kilian.

Source:

*” Winning the Loser’s Game: Timeless Strategies for successful Investing”, Charlie Ellis, McGraw Hill