Investing is not for the faint of heart.  Proof point is the extremes we have experienced in the stock market in the last year or so.  During the worst period of the recent financial crisis that started in September of 2008 and lasted through March of this year, the stock market lost more than a third of its value, and some investors lost even more.  Such sharp declines truly challenge your commitment to your investment strategy.  In this recent bear market many people got so scared that they decided to get out of the stock market completely, and many sworn off stocks for life.

But history insists on repeating itself.   As in many other crisis experienced in the past, the stock market tends to bounce back when you least expect it.  The market has now gained more than 50% since its March lows, and keeps on climbing higher.  For those that sold during the crisis and did not come back to the market, an opportunity to let time take care of market fluctuations has been lost.  What was simply a short-term paper loss for investors who stayed true to their investment commitments, was a real loss for those who got out in the middle of the crisis and did not come back.

The most important lesson here is that you cannot let your emotions drive your investment decisions.  Benjamin Graham, the father of Value Investing once said:

“Individuals who cannot master their emotions are ill-suited to profit from the investment process.”

A study conducted in 2008 by Dalbar, Inc. and Lipper shows that over the period of 1988-2007, the average stock fund returned 11.6% annually, while the average stock fund investor earned only 4.5%.  The difference is what is referred to as the “Investor Behavior” penalty, which in this case corresponds to 7.1%.

Why did the average stock fund investor achieve a much lower return than the average stock funds that they invest in?  The answer is simple.  Investors engaged in bad investment behaviors driven primarily by emotions of fear and greed.  They sold when the market was in trouble (and stock prices were low) and bought when the stock market was doing great (and stock prices were high), which is exactly the opposite of the most basic fundamentals of successful investing: buy low and sell high.  These investors chased the latest hot manager or asset class.  They abandoned their investment plan and lost their long-term investment perspectives.

Simply staying put would have saved these investors on average 7.1% in returns.  To put it in perspective, a 7.1% return would have allowed you to double your money in a little over 10 years.  So if you had $100,000 invested, by letting your emotions get in the way, you lost an opportunity to make an additional $100,000 over a period of 10 years.

Throughout history, the best investors in the world have understood that reaching success in the investment world requires the ability to control one’s emotions and self-destructive behavior.

Being a very successful investor is not so much about how well you know the stock market, how well you can predict the direction of the economy, or even how well you pick stocks and other investment vehicles.  The most important factor in being a very successful investor is developing the ability to control your emotions.