In my last post I proposed that we aren’t necessarily at the mercy of our emotions when investing.  It’s often assumed that only a lucky few are born with the even temperament that’s ideal for investing, and we’re helpless to change that.  However, there are far too many examples of great, but ordinary investors to assume that only a few freaks of nature have access to the emotional stability needed to invest wisely over a life time.  It’s much more likely that most of us have at least a trace of the necessary emotional stability.  And if we have a trace of it, we can strengthen and use it to improve our investing outcomes.  But how do we strengthen our emotional stability?

Bad Habits

Unproductive investing emotions are like a bad habit you want to break.  I’m talking about bad habits like:

• Always worrying about the next market crash
• Panic selling after the market goes down
• Fear of missing out when the stock market is rising
• The greedy desire to somehow “beat the market”
• Chasing after the best performing funds month after month
• Arrogantly trying to pick a few winner stocks out of the haystack of losers.

Similar to the idea that we’re at the mercy of our investing emotions, the common assumption is that most folks are inherently incapable of breaking bad habits.  It’s a popular narrative on the internet, likely because it attracts clicks.  Here are a few examples:

• Most drug or alcohol addicts will relapse.
• Most dieters quickly regain the weight they lost.
• Most smokers fail multiple times before finally quitting, and many never succeed.
• Most people fail to exercise regularly, even though they know they should.

But you don’t have to look very hard to find details that refute this narrative:

• About two-thirds of addicts who successfully abstain for less than a year will relapse, but for those who abstain for a year, only half relapse.  And for those who are sober for 5 years, only 15 percent relapse.
• Some studies show that a significant proportion (around 20%) of dieters are able to maintain weight loss.  And when good eating and exercise habits are established over several years, the rate of successful weight maintenance increases substantially.
• Less than half of smokers who successfully abstain for a year will relapse.  And for those who abstain for more than a year, the risk of relapse decreases over time down to about 10% after 30 years.
• For those who are accustomed to at least occasional regular exercise, less than 40% have substantial lapses in their exercise routine, and most of those lapses are due to injuries of one type or another.

Starting New Habits

While it’s true that many people fail to break bad habits in any given attempt, it’s equally true that many people successfully adopt new habits after repeated attempts over the long term.  Instead of concluding that it’s nearly impossible for us to break bad habits, we should conclude that by continually repeating new habits, we become ever more successful at maintaining them.  This is why John C. Maxwell observed:

• “You’ll never change your life until you change something you do daily.  Success is found in your daily routine.”

This fact should bolster our confidence about cultivating new and better habits, but how do we go about it?  Some useful techniques from “habit expert” James Clear include:

• Develop an action plan with specifics like when and where you will do something new or different from your old bad habit.
• Make a back up plan for when things inevitably go wrong on occasion.
• Use reminders to keep to your action plan.
• Reduce the options and decisions involved with your new habit.  More options have been shown to decrease self-control.

Others suggest these additional techniques:

• Create a reward, even a small one, for each time you complete the new habit.
• Set small incremental daily quotas or steps to reach larger long-term goals.
• Avoid blaming yourself if you skip the new habit one time.  If you skipped a day, instead focus on the fact that you successfully completed the habit 6 days in the last week.
• Share the new habit with a buddy or group.

You can find many real world applications of these techniques in the above links.  Research indicates the time it takes for a new habit to become routine varies by the habit and the person involved.  But research also indicates that, through repetition, a new habit becomes more established and takes less mental effort over time.  The relapse statistics above are good examples.

A Habit to Increase Emotional Stability

While it’s easy to see how these techniques might apply to something simple like flossing your teeth, it’s perhaps less clear what new habit would replace your existing emotional instabilities*.  Mindfulness is a habit that promotes and supports emotional stability.  When we’re mindfully observant of the current moment, and not judging it or fantasizing about the past or future, we are more emotionally balanced and less reactive.  I’ve written a lot about how and why mindfulness works this way, so I won’t repeat it here.  Here are a few articles, if you want to delve into the subject:

• Why mindfulness for investing?
• Handling emotions
• Humility and pride
• Mindfulness and finances in general

If we want to replace existing emotional instability with more emotionally balanced mindfulness, we must practice the daily habit of meditation.  I purposefully use of the word “practice”.  That’s because mindfulness is not something you can just decide to do.  Meditation literally practices a state of mindfulness and emotional balance, just as we practice to become proficient at a sport or a musical instrument.  Without regularly practicing meditation, your chances of ignoring the next stock market crash are about the same as your chances of playing “Purple Haze” the first time you pick up a guitar.

The habit building techniques I’ve mentioned are highly relevant to practicing meditation:

• Develop an action plan with specifics like when, where, and how long you will meditate.
• Make a back up plan to meditate at night, if something interrupts your normal morning meditation.
• Put a meditation cushion where you will trip over it during your typical morning routine.
• Choose one specific type of meditation and stick to it for a few months.
• Congratulate and celebrate yourself for meditating each day.
• Start with shorter meditation sessions and increase the session time as you’re able.
• Focus on how many times you meditated that week, and not whether you missed a particular session.
• Meditate with your significant other, join a meditation group, or attend a retreat.

Reality Check

My core contention here is that by regularly practicing meditation you can make “riskier” investment decisions that have historically performed better.  Think stocks instead of bonds for a classic example.  But how do you know, when the time comes, that your newfound emotional equilibrium will stop you from acting recklessly?

First, there are no guarantees with meditation or any other technique.  Even with the same amount of diligent meditation, one person might balk and panic sell in the next market crash, while another person might resist the temptation.

Second, this is not a pass/fail test.  As you practice mindfulness through meditation, you’ll likely experience a steady improvement in your emotional equilibrium and your ability to resist old bad habits.  We’ve seen that more repetition of almost any new habit reduces the frequency of relapses.  Perhaps, after meditating daily for a year, you’ll be able to weather a 20% market crash.  And perhaps, after two years of meditation, you’ll be able to weather a 30% or even 40% crash without panic selling.  What ever the improvements you reap, it probably won’t be that quantitative.  But the important point is: the more you practice meditation, the less emotionally reckless you’ll likely act in any given future situation.

Third, most meditation involves some form of objective observation of your own thoughts and emotions.  So, the more you meditate, the better you’ll be able to judge your own tolerance for various levels of investing risk.

Expect the Unexpected

I’ve experienced first hand that the daily practice of mindful meditation can cause some surprising incremental life improvements.  I took up meditation with the vague sense that it might help me feel more “balanced”, though I wasn’t sure exactly what that meant.  While this turned out to be true, meditation also helped my life in many other unanticipated and concrete ways.

For example, I used to take Ibuprofen four to five times a week for general muscle soreness, headaches, and the like.  I took it so regularly that I used to call it “Vitamin I”.  Now I usually take pain relievers a few times per month at most.  For me, meditation didn’t take away my pains.  But now, I don’t dwell on them or augment them with an internal dialogue about “how much it hurts”.  When I can be mindful about it, I realize that most of my pains are less substantial and consequential than I used to assume.

If mindfulness can improve something as seemingly tangible as pain, imagine how it might help with those whiffs of anxiety when your portfolio’s value declines by 5% in a single day.  If you suspect I’m some sort of oddity, you can find all sorts of remarkable stories like this at Everyday Mindfulness.  Through mindfulness, many people have found comfort and help in dealing with mental illness, depression, mourning, chronic pain, cancer, imprisonment, drug addiction, violence, sexual assault, and much more.  The goal of being a calmer investor is pretty trivial as compared to most of these success stories.

What’s the Problem?

Perhaps you already feel that you’re pretty emotionally stable, so this all seems unnecessary.  After all, you probably don’t scream at co-workers for not refilling the coffee pot or live in mortal fear with every twitch of your portfolio’s value.  But that’s a pretty low bar for emotional stability.

Set an alarm for half an hour after you finish reading this.  When the alarm goes off, stop and think about what was just going through your head.  You’ll probably find that your current bad habit is to engage in a near constant self-barrage of thoughts that are laden with positive and, more often, negative emotions.  If you could handle that barrage of emotions better by practicing some simple techniques, don’t you think you could be even calmer than your already stoically bad-ass self?

Another reason you might be resisting meditation is because it’s yet another time commitment that sounds difficult to keep up.  I won’t lie, most regular meditators will tell you that meditation is difficult to fit in at first, and it sometimes feels like hard work.  If calmer investing were the only benefit of meditation, then it might not be worth all that effort.  But of course, I’ve already given some examples of how meditation will likely bring you many more wide-ranging life benefits.

Not Deciding is Still A Decision

Moreover, changing your emotional investing habits is probably easier than finding the “best” investment strategy, mostly because the “best” strategy doesn’t even exist for reasons I’ve explored in past articles:

• The world is unpredictable, and what worked best yesterday rarely works best tomorrow.
• The entire idea of diversification means that there will always be some part of your diversified portfolio that’s performing wretchedly (which means you’ll have negative emotions about that).
• Finding a great manager who consistently outperforms is as difficult as trying to do it yourself.

Yet most people ignore these facts and instead concentrate on fiddling with their investment portfolios and tweaking their asset allocations.  They attempt to match their portfolios to their “risk tolerance”, when they can’t really predict how they’ll react to future changes in their “optimized portfolio” values.  Meanwhile, they almost unconsciously assume their emotional habits are “impossible to change”.

Finally, let’s compare mindfulness to the conventional alternative for dealing with unproductive investing emotions.  We’re commonly advised to make “rational decisions” today to protect against your emotionally reckless selves tomorrow.  The most common “rational decision” is to add relatively poor performing, but historically less volatile “ballast” to your portfolio, with the prime example being government bonds.

But is this “ballast” approach really likely to reduce your emotional recklessness tomorrow?  Consider the maximum draw downs since 1972 of a 100% stock portfolio as compared to the often recommended, and less volatile, portfolio of 60% stocks with 40% bonds as ballast:

• 100% U.S. Stocks – 50%
• 60% U.S. Stocks/40% U.S. Bonds – 31%

I think a lot of investors probably sold when the draw down reached 30% and didn’t wait for it to get anywhere near 50%.  The conventional wisdom of adding ballast to portfolios simply ignores the reality that many people will panic and make emotional mistakes anyway.  The advantage of mindfulness is that it works just as well in concert with these more standard approaches, if you wish to use it that way.  So, mindfulness might help you make it through the next market storm with less ballast than you might have otherwise needed.

You may have been able to avoid emotional investing mistakes like panic selling and chasing performance in the past.  But for many investors, the worst conditions the markets will produce in their lifetimes lies in the future, not the past.  So, the more you work on your emotional stability, the less chance you’ll make expensive emotional mistakes in the unpredictable future.

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*Don’t be offended if I assume you have “emotional instabilities”.  I use this term to describe a near universal human condition that is categorically different from being “crazy” or even “neurotic”.