Investment Psychology 101

September 10, 2006 –

psychology.gifEveryone who has ever watched an episode of CSI (Crime Scene Investigation) knows that in order to solve crimes, crime scene investigators must determine a suspect’s motive. Likewise, a key determinant in tracking a serial killer is the psychological profile drawn up by FBI agents. Investment firms are well known for using psychology to sell. Fear and greed are two of the strongest psychological tools available to convince clients to turn their assets over to them for management. Criminal mysteries are often described as a “cat and mouse” game with both criminal and detective playing mind games with each other in an effort to coax the other into a mistake.

The world of financial investing is the same. Only too often individuals concede to the role of the mouse and never assume the role of the cat. And until more individuals assume the role of the cat, they will continue to lose. Unless this is the first time you are reading my blog, you know by now that one of my consistent themes is that you will not discover the truth unless you dig well below the surface deep down into the rabbit hole.

The majority of people tend to be trusting when skepticism should reign and tend to be skeptical when they should be trusting. For example, many people believe that central banks actually enact policy that protects the citizens of their country, believe that organizations like OSHA (Occupational Safety and Health Administration) actually protects workers’ rights, and organizations like the FDA (Food & Drug Administration) actually ensures that the food you and I eat is safe. The truth of the matter is that “corporatocracies”, not democracies rule almost every major country in the world and that corporate interests drive the behavior of these organizations much more than consumer interests ever will. If you wonder why I’ve been spending considerable time discussing psychology recently, it’s because if you want to make the transition from being a mouse to a cat, you must understand the psychology of business.

On and off for the past couple of years, Japan has banned the importation of American beef — the same beef that millions of Americans eat everyday. What makes this beef safe to eat for Americans but not for Japanese? The truth is that we really don’t know if the beef served in America is safe to eat and that’s why the Japanese periodically ban the sale of it to its citizens. The Japanese ban (though recently it has been lifted) has primarily been instituted over concern of BSE (Bovine Spongiform Encephalopathy), otherwise known as mad cow disease. The U.S. claims that it never has had a reported case of BSE, and while this is true, considering that throughout the 1990’s and early 2000’s, only 0.0004% of the 375 million slaughtered cows in the U.S. were tested for BSE, that FDA’s claim that no U.S. cow has ever been discovered to have mad cow disease is basically worthless.

Thus, the reason American beef was banned from Japan. And don’t believe that your country’s regulatory agencies are any better than the U.S.A’s FDA. Because most likely they aren’t. They all cater to the large corporations and act more as an advocate of corporate profits than consumer safety.

In fact despite the fact that cows contracted “mad cow disease” in the past because dead cows were being fed to them, today current FDA regulations in the U.S. still allow dead pigs, dead chicken, and cattle blood to be mixed into cattlefeed. Cattle have five stomachs for a reason – they are meant to eat grass and not meat. And the latest word is that mad cow might infect humans and lie latent for up to ten years before humans display symptoms. Perhaps the only place you should trust the beef as edible is from organic farms and from Argentina, one of the few remaining countries where almost all cows are grass-fed.

Just like the food regulatory agencies, most people assume that financial institutions look out for their best interests as well. But what if this were not true? (I know this is not true, but if you’re not as convinced as I, just consider the possibility that it were not true. Then what?) And even if you are as convinced as I that this is not true, what myths that they have disseminated for decades and decades have you fallen victim to?

For example, I remember when I was a Private Wealth Manager at a Wall Street firm years ago, I met with a prospective client who proceeded for the next half-hour to tell me that he would not do business with a large firm but only independent financial consultants (and generally he was ahead of the curve with this progressive thinking). However, his next question did surprise me. He asked, “How many different asset classes would you place me in?” I believe he asked me this question to see how my portfolio diversification would differ from the guy he was currently employing to manage his assets. This question caught me off guard because his question was not about the best asset classes to be invested in, it was a question of how many different asset classes are too much or are too little? The typical Modern Portfolio Theory method of diversification that all sheep adhere to but that will never build wealth.

The point is even if you recognize one psychological trap and free yourself from its grip, there have been so many psychological traps laid out by the large investment houses over time, that you must completely free your mind of all of them to truly learn how to build wealth.


As with investing, psychology is paramount to the health of a martial artist. Mind, body and spirit must become one. A strong body with a weak mind will create all kinds of psychological problems while a strong mind but weak body will create physical ailments for a martial artist. One of my senseis would always stress sparring and training as if you’re life depended upon it. Why? Because he stated, “if you learn a martial arts technique that could save your life, but you have no confidence that it will work in a real-life situation, then it is worthless.” I absolutely agreed with him. Knowing effective martial techniques without confidence in their efficacy is not worth anything at all.

For most novice investors, even those with significant amounts of money, the relationship they have had with large global investment firms has, psychologically, been a very unhealthy one. The large global investment firms manipulate an investor’s fear of losing money or their greed to build wealth overnight to use ineffective investment strategies to manage their money. Why? Because most global firms want to gather as many assets as possible to increase their bottom line. In order to achieve this “bottom-line” goal, it is impossible for global investment firms to maximize returns for client’s stock portfolios. The majority of time must be spent gathering assets. This leaves little time for deciding how assets should be invested. Therefore, investment strategies that require very little time must be utilized to manage clients’ money. Thus was born the mantra of diversification.

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