In yesterday’s WSJ, Santa Clara finance professor Meir Statman provides a pretty good summary of major investing lessons from the work of behavioral finance in The Mistakes We Make — And Why We Make Them.
Things like: don’t trade on every piece of market news; don’t succumb to hindsight error by thinking something like the Crash of 2008 was obvious; stop worrying about yesterday’s losses; don’t believe all the success stories promoted by the financial-services industry; and don’t get too excited by your gains or losses.
It’s a good article, and I recommend reading it. But there was one major lesson missing from the list: before you deploy your hard-earned capital in risky financial assets, understand why you’re investing.
In my experience, too many investors fail to define their investment goals before setting sail with their investment program. Rather than specifying the time frames and dollar amounts of the goals they’re trying to accomplish, they put their capital at risk with vague objectives such as to “make money,” “outperform the market,” or “eventually retire.” It’s the equivalent of setting sail with the aim of “heading toward the horizon.”
This might be okay for a sunset cruise, but not when you’re crossing the ocean. Failing to know ahead of time what you’re up against and what you can reasonably expect from the markets over time is, to my mind, the biggest investment mistake of them all.
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