Use your head, not your gut when investing

By MoneyWeek Editor John Stepek Jan 16, 2009

John Stepek

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I'm not a big fan of reality TV, although I'll admit to a sneaking fondness for Masterchef. But the other night, I caught the BBC's latest contribution to the genre – and I was hooked. Million Dollar Traders takes eight members of the public who've never been on a trading floor in their lives. A hedge fund manager, one Lex Van Dam, gives them $1m of his own money between them, and with just two weeks' training, he sets them loose to see how much money they can make – or lose – for him in two months.

Unfortunately for Mr Van Dam and the team (although I imagine the TV producers were beside themselves with joy), the two months in question coincided pretty much exactly with last year's financial meltdown. The raw recruits were left staring at red screens at a time when the best trade most of them could have done would have been to whack all the money into a high-interest Northern Rock savings account and then spend the rest of the time relaxing in the pub.

But while the market turmoil made viewing fascinating in a car-crash kind of way, most interesting of all was what it revealed about how people invest and the sorts of mistakes they make. We've all read about how your emotions can scupper your chances of making a decent return (we've written about this several times in MoneyWeek). But it's only when you see this being acted out in front of you that you realise just how much keeping emotion in check matters.

A couple of contestants – including an ex-paratrooper – were simply too afraid of failure to invest at all. They just sat by their phones, cursing themselves for not piling in, as they watched the market move exactly as they'd expected. Another, panicked by an earlier loss he'd made (and we're only talking a few hundred pounds here), tried to regain ground by copying a colleague's successful trade. Needless to say, the market turned and he ended up losing another big chunk of his cash – which he then made worse by getting his 'sell' and 'buy' orders mixed up. Even those who made money seemed thrown by the idea. One trader got very excited when she made a profit by shorting a stock, but then said she felt bad about shorting, because it seemed wrong to hope for a firm's value to fall. This is almost like the reverse of falling in love with your shares – feeling guilty for wishing them ill. Either way, it makes no difference to whether they go up or down in the end.

I'm not laughing at these people – far from it, these are all mistakes most investors will recognise – but next time I'm reviewing my portfolio I'll be taking extra care to engage my head rather than my gut. I'm not sure how much of Mr Van Dam's $1m will be left by the end of the series, but I reckon watching other people make a mess of investing his cash could save you some pennies in the long run.

Published in How to invest | More articles by John Stepek

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