What Makes Us Feel Pain In Investing?

Why do we feel pain in investing? Is it good or bad? And how can we cope?

When I was a young analyst over two decades ago, I was fortunate to have a great investing mentor. I started in the industry as the Internet stock bubble of the late 1990s was bursting. My mentor was a portfolio manager who launched his fund in the early 1990s and followed a rigorous value investing approach. By 1999, his performance was lagging well behind the market which was driven by speculative stocks that his process steered him well clear of. His sister-in-law redeemed her investment from his fund, and wrote to him that he “didn’t get it” and that she was able to make 20% returns in just 6 months by levering her money via credit card borrowings.

That’s painful. But why? In the great investing classic The Money Game by “Adam Smith,” the author suggests that investing is about Identity, Anxiety and Money. In that order.

The order is important, because it really isn’t about the money. My mentor surely had enough money where he could live a very comfortable life even with poor relative performance by the time 1999 rolled around. He was certainly not in any danger of starving or being deprived of life’s other necessities.

No, he was not. Nonetheless, I can only imagine how painful it must have been to have spent almost a decade toiling away just to have his results compare very unfavorably with the market and his family members thinking that he didn’t know what he was doing.

Imagine that you have a singular identity, which is that you are an investor who is going to produce a high return that will exceed the market. That is who you are, in your mind. So how does pain work?

Let’s look at a small pang of pain in that scenario. You buy a stock. It goes down. That causes anxiety. Why? Because the fact that your investment went down in price challenges your identity as an investor with high returns.

Now imagine several years of underperformance. That starts to really challenge your identity. And bring on massive pain.

But what identity is a successful investor supposed to have if not that of someone with high returns? I am glad you asked.

First, you have a choice as to whether to have an outcome-based identity or a process-based identity. In the former, you are your results. In the latter, you are what you do.

What good is process if the outcome isn’t there? Of course we want the right outcome. However, it needs to be measured over an appropriate length of time. In investing that’s at least one market cycle, usually 7 to 10 years. Furthermore, if you have a good process and you execute it consistently, over the long-term the outcome is very likely to follow.

So imagine that you have a process-based identity. You are what you repeatedly do. You follow your process. It leads you to buy a stock. It goes down in price. Will you feel pain? Not necessarily. The fact that the stock went down in price doesn’t challenge your identity of someone who follows a certain process as an investor, unlike someone who defines themselves by their outcome.

What’s more, you aren’t limited to a single identity. You are not a good investor or a failure. You can have an identity as an investor. An identity as a parent. An identity as a friend. You get the point. So you can choose whether to adopt a one-dimensional identity or a multi-dimensional one. The latter is more robust, and should keep you from the depth of emotional despair when you are going through a hard time in one aspect of your life.

Let’s say that you have adopted a process-based identity, and a multi-dimensional one. Well, in that case pain can actually be good. How?

If you have a process-based identity as an investor, what should cause pain? Not a temporary change in the market price of one of your investments. Perhaps, deviating from your process should cause you pain. If that’s the case, that pain is a helpful signal for you to change your behavior. It’s your mind holding you to your commitment to yourself to perform at a higher level.

Just because pain can be useful doesn’t mean that it’s not still… painful. So how should you cope?

During the 2002 market sell-off, every portfolio manager at the firm where I was a young analyst was seeing red on their Bloomberg screens. Not a lot of fun. One day, a few of us were walking past the office of one of the senior portfolio managers. His Bloomberg screen was full of green.

Unable to restrain our curiosity, we asked him how he was crushing the market on another big down day. He smiled, and said that he couldn’t take the pain, and changed his Bloomberg settings to color-code declining stocks as green and rising ones as red.

That’s one way to cope. However, you are unlikely to fool yourself for long. So what are some better ways to cope?

I have found that talking to peers whom you respect can be one way. They can be an honest sounding board when you doubt yourself and how you are executing your process. Another way is to remember your multiple identities and, while acknowledging and addressing the challenges that you are having in one of them, take pride in some of the successes that you are having in your other identities.

To summarize – define yourself by what you can control and what you do, not by short-term outcomes. Use pain as a signal to improve. Finally, surround yourself with those whom you respect enough to give you useful feedback. Oh, and remember to be kind to yourself. We are all only human.

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