How to Keep Your Head in a World Gone Mad

“The whole world is mad. Stocks will be dropping 30 percent, then rallying 20 percent, and dropping another 30 percent – that’s going to be the pattern. And whoever can’t live with that shouldn’t be buying equities at all.”

These are the words of noted investment guru Marc Faber, the author of The Gloom Boom & Doom Report.

Seeing the way stock markets are reacting these days, it does seem that the world has indeed gone mad.

But as Faber says, if you can’t live with the current uncertainty and volatility in the stock markets, you must not be buying stocks at all.

Now the question is – how do you live with so much uncertainty and volatility out there and still keep your otherwise level-headed thinking intact?

The answer lies in how you manage your emotions while investing (and staying invested) in stock markets.

We discussed in the previous post how people with financial intelligence have fared so poorly as investors in the past. We talked about the rise and drastic fall of LTCM.

Let’s take another example…this time of how ‘general intelligence’ isn’t enough to make you a successful investor.

Have you heard of Mensa?
Mensa is a society that limits its membership to people with IQ’s (intelligence quotient) in the top 2% of the population.

The only requirement for membership to Mensa is an IQ in the 98th percentile or better (in simple terms, you must be ‘super intelligent’ to qualify). Currently, Mensa has over 110,000 members across 100 countries.

So far so good! Mensa is an esteemed organization, and you would definitely want to be a part of it.

Now take this. It turns out that Mensa has an investment club. Given the high level of intelligence of its members, it can be assumed that this investment club would’ve had a good history of beating the markets in the past, right? After all, they are the smartest people in the world making investment decisions.

Well, don’t draw any conclusions so fast! During the 15-year period between 1986 and 2001 (for which the data is available), the US stock markets (S&P 500) generated average annual returns of 15.3%. Against this, how much did Mensa’s investments earn?

Data Source: Moneywatch

Now that would be 84% worse than the index…and worse than even the worst of mutual funds that must have operated during that period.

So much for the super normal ‘intelligence’ of Mensa’s members!

Here is what Warren Buffett has to say about IQ and investing…

“Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ….What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.”

It’s not IQ, but EQ that counts more in investing
Yes, successful investing is all about having the right amount of EQ, or ‘emotional quotient’ (the measure of a person’s emotional intelligence).

This is what Daniel Goleman, the author of Emotional Intelligence has been promoting since the 1990s – that success is more closely tied to emotional intelligence than education or knowledge.

As he wrote in his book…

“As we all know from experience, when it comes to shaping our decisions and our actions, feeling counts every bit as much – and often more – than thought… Passions overwhelm reason time and again.”

Goleman argues that two key aspects of emotional intelligence are:

1. Impulse control, and
2. Persistence

These are exactly the two qualities that will keep you from abandoning your investment strategy in a panic.

Rational behavior doesn’t causes dramatic short-term swings in stock prices, as we are seeing now.

It is fear and greed, plain and simple.

See, as far as the current uncertainty and volatility in the stock markets is concerned, we’re still in the early innings.

As such, this situation is likely to be with us awhile.

What does this mean for you as an investor?

It means that to hold your head when others around you are losing theirs, you need to use your EQ, not your IQ.

How to be emotionally intelligent?
Here are three ways you can use your emotional intelligence while investing in stock markets:

1. Have realistic expectations
Stock market is one place where trees are expected to grow to the sky. However, you must resist the temptation (especially during a bull market) to think this way. Similarly, during panicky times like what we’re seeing now, avoid expecting the world to end and the markets to close down. Things always get normal. It only takes time.

2. Resist the urge to “do something”
It’s one thing to feel fearful about the market. It’s quite another to let that fear crush your well-laid investment plans. Resist the temptation to ‘do something’. Resist the urge to push the panic button. Your impatience can turn out to be a bigger disaster for your portfolio than any stock market crisis.

3. Automate your investments
If you’re just starting out on your investment journey and have many years left for accumulating wealth, use a discipline like dollar-cost averaging – investing a consistent amount at regular intervals – to take advantage of the market’s occasional volatility. A systematic investment plan (SIP) in a good mutual fund can help you do that.

We are humans and thus can’t protect ourselves against occasional bouts of emotional outpourings. But it’s safe to say that if you let those emotions control your investment decisions, eventually you’ll be left with nothing but regret.

So, use your emotional intelligence while investing in the stock markets.

Don’t panic. Simply take a chill pill.