What Warren Buffett said: Evaluate Investment Based on Your Inner Scorecard / Criteria, do not be emotional investor
A while back, there was a "Master Class" on PBS where Warren Buffet and Bill Gates were on the same stage fielding questions from University of Nebraska business students. One of the things they discussed is your "inner scorecard". (The program is called "Buffet and Gates Goes Back to School")
An inner score card, according to Mr. Buffet, is basically your own inner compass on how well you did, and so on. It may also be referred to as "principles" or "conviction". He said that most people worry too much about what the world would see his choices, i.e. "outer scorecard". People are naturally risk-averse, so to make brilliant decisions, you have to go AGAINST the group. Buffet went as far as saying that large groups CANNOT make brilliant decisions.
When you invest, you need to keep your inner score card, or else you will be lost.
Temptations of Outside Scorecard
When your friends and family know you invest, they will bombard you with tips, and belittle you when your investments go down, and tell you to sell, sell, sell... And basically bombard you with EMOTIONS. There may be information in there, but most of that would be emotion. People giving you tips left and right, but you don't know any of the stocks they're talking about... You end up with "I like that company's name" or "I heard the name of that CEO on the news the other day", or "I think that guy wrote a book", or "my best friend recommended it."
Makes you feel like a day at a horse racetrack, doesn't it? People eager to give you tips (buy this horse! buy that horse!) except you have absolutely NO IDEA which horse to bet on. In the end, you end up with something as nonsensical as "I like that horse's name" or "I think I heard of that jockey from somewhere" or "I like the jockey's jersey color" or "my best friend recommended it".
Really, most people invest the same way. If you ask them WHY did they buy that stock, few would be able to articulate a logical coherent answer.
As we have discussed before, you cannot invest on emotion (alone). It is a sure way to disaster.
Logical Investor vs. Emotional Investor
Some beginning investors have little money, so they don't invest in the big caps. Instead, they invest in penny stocks, or the hot stocks they see on TV. What they don't understand is while those stocks are cheap, they also fluctuate the most. They think that is where they'll "make a killing". Thus, when the market goes up, the stocks generally go up for no reason, and they're happy. When the stock goes down, they start mumbling why did it go down when the company is good. They don't seem to understand that the market has a split personality:
In the short term, the stock market is emotion driven. If one company reports a problem, or lowers the outlook, the entire sector suffers. And vice versa. In today's connected global economy, a problem anywhere in the world will affect industries all over the world.
EX: if Microsoft lowers earning forecast for next quarter, ALL software, like IBM, Sun, Oracle, CA, etc. will go down a bit, ALONG with Microsoft, just because they're in the same sector, even though everybody else did nothing. Conversely, if Microsoft had released a BETTER than expected outlook, everybody's stock goes up (a little).
In the LONG term (6 months to a year or more), the stock market is logic driven. The "fever" blows over, then people are driven to the fundamentals: the overall economy, and the company's earning vs. assets and liabilities.
Most investors look at the stock prices every day, even multiple times a day, fret over daily price fluctuations, lament about "lost opportunities" and moan over "great losses", but they also boast "big deals' and 'bargain picks'.
Frankly, most investors are gamblers. They understand nothing of the market, but they play in it any way. There is no such thing as minimum competency when it comes to the stock market like there is to drive a car. Thus, most investors take the short term view: driven by emotion. They are caught up in the mania of the high, then the panic of the low, and ending up doing the exact opposite of what they want to do. Instead of buy low sell high, they end up buy high and sell low. Then they blame the stock market.
The REAL investors invest by LOGIC, like Warren Buffet. They don't buy stocks in companies they understand nothing about. Instead, they simply clean up after the mess the emotional investors left behind. When the emotional investors goes "sell sell sell!" The logical investors buy low, and wait for market recovery to sell high.
In a sense, the logic investors love the emotional investors. Without the emotional investors, the logic investors could not have made that much more money. One more reason the rich got richer.
Keep your Inner Scorecard. That is your mechanism to hold the forces of mania and panic at bay. You have your own criteria, don't let the fever of mania and panic drag you along.
Be Spock (tm), in other words. :) (That's Spock from Star Trek) Be logical, not emotional. Only your own criteria, your own inner scorecard, is important when it comes to your investment.