One definition of investment discipline is: do you pull the trigger when your investment process tells you to buy or to sell a certain number of shares of stock? Do you transact the number of shares your process tells you to transact, or some other amount? Discipline means consistently following your investment process.
I believe the key to discipline is managing willpower. I learned a lot about managing willpower from the outstanding book, Willpower: Rediscovering the Greatest Human Strength by Baumeister and Tierney.
According to Baumeister and Tierney, we have a certain reserve of willpower each day. Our reserve depends in part on how much glucose we have in our blood stream. Willpower is needed continuously to suppress emotions so that one can function effectively during the day. Some activities and events consume vast amounts of willpower, in particular what you would otherwise not do (e.g., exercising, being polite to people you don’t like, not eating sweets, etc.). When you run out of willpower it becomes very hard to remain disciplined.
Glucose alone does not mean we will have the willpower to take on our most challenging tasks. Sometimes we must think through the structure of our life. Poorly structured tasks take more willpower. One can revise such tasks so that one needs less willpower to complete them.
If we manage our willpower effectively, we may have enough to be disciplined when it comes to following through on investment decisions.
TRADE at times of peak willpower
I find that I am much more disciplined when I trade in the late morning. I have more willpower then compared to other times of the day.
Every weekday I complete my morning exercise by 6:30AM. Afterwards, my glucose levels are low and thus my willpower is shot. So I need to rebuild in time for trading.
I rebuild my glucose (and my willpower) by eating a decent breakfast at 7AM, typically about 500 calories in a well-balanced meal of fat, protein and carbohydrates. The early breakfast gives my body some time to convert the food into glucose to recharge my system and my willpower.
I will start planning out my trading around 8:00 AM. This will take up to 90 minutes. This is not very difficult to execute, so it doesn’t require a lot of willpower. Meanwhile, I feel all of my mental acuity coming back as my blood sugar level returns to normal.
By 9:30 AM to 10:00 AM I start trading. I find that I can breeze through the trades without the minimum level of emotions until about 11:00 AM. I try to have everything completed before lunch.
If trading starts to run for too long, the energy from my breakfast will start to deplete and I find it difficult to remain focused. Without focus, discipline disappears. I might have to take a break and eat a decent lunch.
In the afternoon, no matter how much I have eaten, I am fighting a downward slide in my willpower. I just don’t have as much as the day wears on. Thus, I try to avoid trading late in the day.
SPEND LESS TIME FOLLOWING THE MARKET
Like most people, watching the value of my brokerage account go up and down creates an emotional reaction. Statistically speaking, the information likely has little or no value in the near term. I just as well could look at the account once per week, once per month or even less frequently.
Merely watching the market reminds me that I have money in the market which is fluctuating, creating an emotional response and using up willpower. For the kind of investing that I do, I need not look at the market more than once per week. My investment process is not designed for a shorter time period. Therefore, observation of the market over a shorter time frame creates an avoidable drain on my willpower.
FILTER THE MEDIA
A major goal of media organizations is to get people to read or to view the stories they create. One way they do that is by running sensational stories that provoke strong emotional reactions. The media are very good at this. Otherwise, they would not be in business.
I make a conscious effort to filter what I read. If I suspect that my process will want me to buy more stocks in a few weeks, I try to avoid reading news media that bleats about the terrible state of the economy and the markets. If I read such stuff, when it comes time for me to buy, I likely will have to fight through a particularly strong emotional response. Why should I make discipline more difficult than it already is?
Filtering the media does not apply just to investment related news and opinion. Any media that creates a strong emotional response may be a problem because dealing with any emotional response draws down the willpower one needs when it is time to take actions with one’s investments.
For some people, politics creates a strong emotional response. The more one reads about politics, potentially the more one experiences the negative emotion of frustration. Dealing with that emotion takes willpower. Perhaps one could improve investment discipline by paying less attention to politics.
Trading less often
Simply taking action on an investment opportunity requires willpower. The more actions one must take, the more willpower one consumes. As the willpower runs down, the investor will find it increasingly difficult to follow through and take action.
Therefore, one may improve investment discipline by designing an investment process that requires less action. For example, trading once per quarter may require less willpower and discipline than trading every day. While the daily strategy may have higher theoretical performance, the performance will not happen if the investor cannot keep up with the demands of the strategy. A quarterly strategy may have a somewhat lower (but still attractive) theoretical performance, but the performance actually happens because the investor can follow through.
Make smaller investments
Position size can affect investment discipline. The more money one puts at risk in an investment, the stronger the emotional reaction. If one has difficulty following through on investment decisions, perhaps the size of the investments is too much in relation to one’s available willpower.
Reducing the amount at risk may pave the way for more consistency. One could diversify one’s assets across more positions, so that buying or selling any one position does not take such an emotional toll.
Alternatively, one could have fewer positions but spread the trading of any one position over several days of weeks. Of course, the viability of stretching the trading out over a period of time depends on the strategy. A rapid-fire strategy might not lend itself to this approach; for a longer-term approach, slowly trading in and out of positions might not affect performance too much.
CONFIDENCE IN PROCESS
Uncertainty triggers emotions, especially when the stakes are high as is the case with investing money. If one becomes uncertain as to the future return potential of one’s investment process, one must use substantial willpower reserves to deal with the emotions and to follow through with discipline.
One can reduce the emotional toll of uncertainty by building confidence in the investment process that one uses to invest in stocks. How does one do this?
- Use an investment process that is well-supported by evidence. In our opinion, the evidence strongly supports value and momentum as stock selection methodologies. When in doubt, one can reduce uncertainty and reestablish confidence by consulting the historical evidence.
- Read at least 10 books or papers that explain why your investment process should achieve the desired result. The cumulative weight of the evidence should reduce uncertainty. If you cannot find at least 10 books or papers and you don’t have the tools and resources to establish beyond a reasonable doubt the efficacy of your investment process, perhaps you should consider a different investment process.
- Write a five to 20-page essay explaining why the investment process should work. Writing forces clear thinking and increases one’s commitment to the investment process. A long essay requires a thorough assessment of the investment literature.
- When feeling doubtful, reread the literature.
HAVE MORE THAN ONE INVESTMENT PROCESS
As they say, there is more than one way to skin a cat. Similarly, there’s more than one way to succeed at investing.
No investment process produces attractive returns all the time. During the inevitable periods of poor performance, those who follow the investment process will suffer an increasing emotional burden. Those bad emotions rapidly drain willpower. The investment process becomes increasingly difficult to follow.
Having more than one investment process can help. If one has two investment processes that operate on distinctly different principles, there may be a good chance that one will perform well when the other performs poorly. Overall returns may not look as bad and the emotional toll may be easier to bear.
If taking action requires too much willpower, having someone else take action on behalf of the investor requires less willpower. The investor designs the investment process and turns it over to someone else to manage on a day-to-day basis.
Because it is not his money, the person actually taking the action will have no “skin in the game.” He is a mere order taker and will not have the emotional attachment to the outcome. If anything, the order taker will have to push through the fear of making an error in the actual entry of the order. However, a diligent trader can avoid such mistakes without too much difficulty.
At the same time, the investor himself will not have to deal with the emotions caused by trading – it has become someone else’s problem. Consequently, there is a diminished likelihood that failures of willpower will cause abandonment of the investment plan.
I started Crossfit in February, 2015, after doing essentially no consistent exercise for about 30 years. My oldest son had been doing Crossfit for a while and it appealed to me. But the intensity left me thinking that I ought to get in shape before joining a Crossfit gym.
The catalyst for not waiting was a party at which I became winded after dancing with my wife for only two songs, and not particularly fast songs at that. At that point, I decided that the situation was grave and that I would start Crossfit immediately. I have been going six days per week for the past 20 months.
Crossfit is very hard work, but it requires less willpower than one might think. I sleep in my gym clothes, thereby making it easy to get ready in the morning. Once the alarm goes off, all I have to do is get into my car and drive three miles to the gym. The rest is on autopilot: the coach has the workout planned and all I need to do is follow instructions. Because I am in a class, peer pressure makes it inevitable that I will work hard. The motivation is external rather than internal and requires less willpower. At Crossfit, there’s no sitting on the rowing machine reading a magazine.
For me, Crossfit initially consumed vast amounts of willpower. It was very intimidating. Over time, it became a routine. At this point, I don’t feel like I need to use much willpower to get myself to go.
Crossfit has helped my investing. Specifically, the arduous exercise has led to a steadier emotional state. Things that used to bother me don’t bother me as much since I started Crossfit. Consequently, I find that unwanted emotions are not draining my willpower as much as they used to. I now have more willpower to deal with other challenges (like pulling the trigger on investments).
A well-designed support structure can help one follow an investment program. The support structure consists of one or more trusted people who hold the investor accountable for following an agreed-upon program.
Facing a challenging task alone requires more willpower than acting as part of a group. When one is part of a group, one does not want to disappoint. The fear of being a disappointment can help one overcome the emotional barriers to taking action on one’s investments. The fear provides an external motivator such that one needs less internal willpower.
The group should meet regularly, perhaps once per month. In the near term, investment results can be unpredictable. It does not help to focus on what lies beyond the control of the investor. Instead, the group should focus on the consistent implementation of the plan. For example, the plan called for buy 1,000 shares of XYZ Company on Thursday. Did the investor do it or not? Why or why not?