The book “The Psychology of Money: Timeless Lessons on Wealth, Greed and Happiness” was written by Morgan Housel, a former columnist with the “Wall Street Journal”.
In it, he discusses emotional aspects that influence how financial decisions are made, which, once identified, allows one to better understand oneself.
There are points in this book that could shape you into becoming a better stock investor. Here are the top five lessons.
1. Getting and staying wealthy are two different things
The book suggests that the mindset and skills for obtaining wealth are vastly different from maintaining it. The former requires an element of risk taking; the latter avoids risks and is driven by a “survival” mentality.
In other words, a person who intends to get wealthy would invest differently from one who plans to keep their wealth in stocks.
Those who wish to get wealthy might emphasise more on returns, leading them to trade stocks for quicker profits, or buy them with leverage such as margins and contracts for difference. Their focus would be on how much money could potentially earn from their trades or investments.
Meanwhile, those who intend to stay wealthy would focus more on the business sustainability of a stock and mitigate downsides from buying it. This would involve them assessing the stock’s financial strength and valuation before deciding on the investment.
2. High savings vs high returns
Let’s say Mr A and Mr B both earn RM10,000 in monthly income. If Mr A saves RM5,000, or 50% of his salary, he would in a year have as much as RM60,000 in capital.
Assume Mr A is an average investor who could earn a consistent return of 5% per annum from his investments, which amounts to RM3,000.
Now, let’s say Mr B saves just 10% of his monthly income, or RM1,000. He would need an investment return of 25% per annum if he wishes to get the same RM3,000 in annual returns from investing RM12,000, which is one year’s worth of his savings.
The lesson here is that an average investor such as Mr A could still build wealth if they had a high savings rate.
3. Include room for error
Investors are only human, and it is all too common for mistakes to happen when it comes to their financial decisions. As such, it is crucial to include room for error when building your stock portfolio.
Always ask yourself: “What would the impact be to my net worth if the price of my stock fell by 50%?”
If a person invests RM10,000 into a stock and it drops 50% after they purchase it, they would likely be less emotionally affected than if they had an original net worth of RM1 million before making the investment.
4. Stick to your plan
This talks about the importance of recognising that different people will invest differently based on their own needs, wants and personalities.
Dividend investors who intend to keep wealth via amassing a portfolio of fundamentally solid dividend-yielding stocks for the long-term would build an investment plan. This would comprise their stock selection criteria, valuation, and risk-management practices based on their objectives.
Along the way, they might find some good-quality stocks, but this does not mean they would make a major investment if it does not fit into their plan.
Before you invest, it’s vital to know what is suitable for you and what is not. Stick to your plan, and don’t trade or speculate.
5. Freedom is the highest dividend
Dividends provide you with more choices as to how you wish to spend your money. You could use the earnings to pay bills, buy meals, fund a vacation, donate, or even reinvest.
Essentially, investing for dividends is investing for freedom.
There are many more lessons to be discovered from “The Psychology of Money”, so grab yourself a copy for leisure reading or to motivate you in your investment decisions.
This article first appeared in KCLau.com. Ian Tai is a financial content writer, dividend investor, and author of many articles on finance featured on KCLau.com in Malaysia, and ‘Fifth Person’, ‘Value Invest Asia’ and ‘Small Cap Asia’ in Singapore.