Knowing how to set a goal is something very powerful for an individual psychology.
However, doing it right is not so obvious, and it requires good analytical skills, but not of external factors as you might think. Let’s continue to understand what we mean.
“If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle.”
(The Art of War – Sun Tzu)
So he said this famous Chinese general and philosopher lived 2500 years ago. At first glance it may seems the usual cliché, but in the reality the concept he wants to express goes well with the psychological foundations that underlie the investing art.
Let’s start by making a clarification: when you invest there are no enemies, there are no good nor bad ones. When you invest, there are the goal you want to achieve, and the related risks. So, we can start by changing the Sun Tzu sentence in “If you know your goals and know yourself, even in a hundred investment you will NOT be in danger.”
First investment goal: being master of your own money
Being masters of our own money, which translated means also to invest personally, having a goal and, above all, having the theoretical foundations to be able to reach it, places us in the favorable position of knowing what are the risks we can encounter.
Knowing the risks associated with the achievement of a specific goal is really the starting point for a good investment. It would not make sense to start any activity without first having established what would be the risks. To continue without knowing them can easily turn into irresponsibility.
Second investment goal: knowing yourself
Once your goal is clear, and then you know all the risks related to it, at that point you have to make another type of analysis, but directed toward yourself.
You have to be honest, to admit your limits, to predict your possible reactions and your tolerance levels.
To make a practical example, let’s suppose you have two investment strategies available. Both aiming to achieve a 50% profit of your initial capital. The first statistically succeeds in just one year, risking 50% of your fund, while the other takes two years statistically, but risking only 20%. Which of the two investment strategies would you choose?
Many respond without fail that they would choose the former. “Why choosing the latter if the goal is the same, but the first one takes half of the time to get to 50%?”. And for many this would indeed be the best choice. But let’s try to imagine a possible scenario considering the first strategy.
We begin our investment, and by accident the strategy enters a negative period, and within 3 months you get that 50% losses statistically forewarned. Although it is not easy, try to imagine how you would feel if after 3 months you would have not yet accumulated a single dollar of earnings, but rather you would see your account totally halved. I can assure you that for very few in the world that would not be a problem at all.
Nobody likes losses, and losing half of the capital can really be a bad shot. Anyway, in losses you can also discover the spirit, the courage and the steady nerves of an investor.
In fact, the savvy investor who had used the strategy 1, passed those three months and finding himself without half of his account, would analyze again all the conditions that led him to choose that strategy. He would pass them all in an analytical review and would reason with a clear mind. He would conclude that the right conditions are still in place, so he would decide to continue with the strategy, and he would then be rewarded.
After the negative moment, the strategy begins to scores excellent profits and in the following nine months the account recovers all the losses and reaches its target even before the year.
Now, this is just a fantasy scenario, and with a nice happy ending, but you can imagine how many would not be comfortable at all with that kind of risk, despite the prospect of the saved time might be interesting. Many people, knowing themselves and their possible reactions, would prefer to choose a safer way, that arrive at the same result, in twice the time, but also with less than half of the risks.
Knowing yourself also means being aware of the condition or situation you find yourself in. A pensioner may have a different time horizon from a young worker just come of age. But not necessarily.
A pensioner might want to invest on a very solid and contained plan just to save his retirement from inflation. Or he might want a more ambitious plan for a portion of his savings, to try to leave something more to her grandchildren.
A young man, in the same way, could look for a strategy for a capital he’s planning to accumulate for at least 20 years, for which he wants to be conservative and not risk to have surprises. Or he might aim to double the capital in 2 years to buy the car of his dreams, and because of that is willing to risk more.
These are all examples to make you understand how the goals may vary depending on the personal circumstances of each one of us.
Goal means gain, but it means above all “possible risk”
In this regard, Peter Lynch says that the
“key organ for investing is the stomach, not the brain”.
He doesn’t mean you should not reason about the decisions and you should rely only on instinct.
He more wisely means that, once assessed the situation and made the necessary reasoning, if inside you, even at an emotional and physical level (in the belly), you feel that something is wrong in that investment, for example, that you would not be able to bear the risks, then you definitely need to, at least, stop and reconsider, if not abandon the project altogether.
So, do you know yourself deeply enough to understand what your goals are and the risks that you would be able to bear?