Saturday, August 12, 2006

Principle #8 - Understanding Influences

As investors we are constantly subject to a number of external and internal factors which influence our decision making. These influences and the way we respond to them can have a powerful effect on the decisions which we make. While it is unlikely that we could make any decisions without external influences, we also need to recognise that both internal and external influences can be detrimental as well as beneficial to our decision making process.

Spending a few minutes considering what has influenced a decision before making an investment can help avoid costly mistakes. Investors who allow themselves to be influenced by the hype and stories of other people making fortunes have usually ended up losing money whether it was on tulips (1635-37), the South Sea Bubble (1711-1722), Japanese equities (late 1980s) or technology companies (late 1990s). It is so often the case that if investors simply asked themselves "does this make sense?" before they part with their hard earned money they would have been a lot better off.

Here's an example. What kind of person buys shares in companies that have no earnings, no established business, no track record and which expects to run out of cash in a few years? The answer is a lot of people who allowed themselves to be influenced by hype, stories of quick and easy wealth and glowing recommendations from "professionals" and brought into the dot com boom. Sure, some people made a lot of money but a lot more people lost out as well.

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