Investors Must Preserve Emotional Capital Too
I’m a buy-and-hold fundamental investor, but I follow a lot of traders on Twitter. I do this for two reasons. First, a lot of them are interesting and funny dudes (they’re almost all guys). But second, I recognize that some traders do actually make money on a consistent basis, and that the reason the money-makers do so is because they follow rules, and possess wisdom. And that’s applicable to fundamental folks like me.
Sunrise Trader had a great tweet this morning, that encapsulated what makes a good trader:
- Our job is to look for opportunity, manage risk, consistently take profits out of the market while preserving emotional and financial capital.
This is very applicable even to buy-and-holders like me. I’m not taking profits out of the market often — only when I think a stock is really stretched beyond its fair value. Instead, I’m just adding new capital every month from my earnings. But sometimes I must take profits. The really important thing that struck me again though is the importance of preserving emotional capital.
Notice he put that before preserving financial capital. The first leads to the second. For the buy-and-hold guy like me, you preserve emotional capital in three ways:
- Size your positions appropriately. That means at a level you are comfortable with. I never hold more than 30 different companies. But never fewer than 10. That’s what I’m comfortable with. You may be comfortable with a different number. If I put all of my money in one or two names, I would not be preserving my emotional capital. This would leave me more prone to doing something stupid like selling on a dip even when I believe in the company. As I grow as an investor I hope to shrink the number of companies I own. But there is no reason to force it.
- Invest over time. I add money to my investments every month, incrementally. It is much harder emotionally to invest $100,000 or $1,000,000 or $1,000,000,000 all at once than it is to invest whatever your total capital is over a period of months. This also gives you additional time to scale up in positions as you gain comfort and additional knowledge of the companies and the industries in which they operate.
- Buy-and-hold. This itself is a means of preserving emotional capital. I am sitting on huge gains in Microsoft stock that I purchased at about $18/share during the financial crisis. I bought Intel for the first time at around $13/share during the financial crisis. I have held those positions. I bought Walmart under $50/share in 2010. I have held. Etcetera. This is not to say I never sell. Stocks I have sold at advantageous times include Hewlett Packard, Transocean, Tidewater and Exelon, and less smartly, Ebay and Disney. But if I think my qualitative thesis is blown or the stock is way overvalued, I sell. That’s my rule. Sometimes I win, sometimes I lose, but I follow a rule, just as traders do. (It’s just that my rule isn’t a price point based on technicals.) When you are a buy-and-hold investor, and you follow decent selling rules, and you sit on long-term winners in whose business models you still believe, you see a lot of green on your screen after a few years. This gives you emotional capital. This makes you more confident. This makes you less likely to do stupid things, even with your newer positions.