6 Life Lessons from the Stock Market

If you’re in a bad situation, don’t worry. It’ll change. If you’re in a good situation, don’t worry. It’ll change.

~ John A. Simone Sr.

Update: This post is featured in the Carnival of Personal Finance #252 at The Wisdom Journal. Thank you!

I’ve written before that I’ve learned quite a bit about investing and economics over the past few years. That’s true, and I still have a lot more to learn. But one of the things that has really struck me as a former financial neophyte is how much financial markets have in common with life.

I used to think the market was a venue for making money run by people who cared a little too much about material gains. Time and my Green Eggs and Ham “try it” philosophy taught me that I was wrong.

The truth is, markets are run by people. But those people are not necessarily any more evil, good, or any other adjective you might choose than most other people. They are therefore subject to the same fits and foibles as any other group of human beings. In fact, I think I agree with Pop over at Pop Economics that crazy people rule the market. A lot of them may be people with MBAs and PhDs, but they’re just as human as you and I.

6 Lessons the Stock Market Taught Me

1. Have a Plan: Whether you’re considering an asset allocation strategy, a budget, a set of standards for your kids, or setting up a garden, it’s important to sketch out a plan before you act. The plan should include a purpose or goal and reasons why you chose a certain course of action over several other alternatives. That way, when you go back and evaluate your plan, you can remember why you made the choices you made. If it’s going well, great. Stay the course. If things aren’t going the way you’d like, try out one of your alternative choices or re-evaluate your purpose.

2. Have a Plan B: Contingency plans are always important, whether you’re talking about an investment decision or not. Any plan should always include a “what if I’m wrong” clause. Have a course of action ready in case things don’t go as planned. What will you do if you get sick, lose your job, or come into some unexpected good luck?

3. Risk vs. Reward Analysis: I covered this in detail in Risk vs. Reward: The Ultimate Calculation, so I won’t belabour the point here. Any decision you make can benefit from weighing the pros and cons and deciding how important each factor is to you.

4. Let Your Winners Run: This is basically a reiteration of the old “if it ain’t broke, don’t fix it” adage. If your plan, financial or otherwise, is going well, resist the urge to tinker. It’s like those cooking shows where they tell you to sear one side of the meat well before flipping it over. If you handle or manipulate the food too much, you’ll end up with something that resembles a piece of leather rather than a juicy, gourmet dish. Still, many of us can’t resist shifting, poking, or worst of all, pressing down on it with a spatula! Give your plan the room it needs to play out and remember: tampering often leads to hampering.

5. Cut Your Losses: If you’ve given your plan some time and it’s clearly not working, it’s time to make a choice. Do you give it a little more time, move to Plan B, or start working on Plan C? I admit that I probably shouldn’t be giving any advice in this area, since I tend to perpetually cut losses either too early or too late. It’s always a tough call to make, but if your instincts (and the facts) are telling you it’s not working, chances are you need to change directions.

6. Mean Reversion Rules: All trends eventually end. The trick is to recognize when that has occurred and prepare for it in advance. Life, like the markets, seems to have cyclical peaks and valleys. A good rule of thumb is to be the ant. If you’re experiencing a run of good luck, make provisions for when your luck turns. Chances are it will do so at some point, and if it doesn’t, you can rest easy knowing that you are prepared. If you play the grasshopper, you are likely to suffer a particularly harsh winter.

If you’ve been experiencing difficult times, find solace in the fact that “this too shall pass”. Up or down, no trend lasts forever. Keep plugging away, and eventually your downtrend will end too.

For me, these lessons (especially the mean reversion one) really brought home the ubiquity of balance and, to some extent, helped spawn Balance Junkie. Right now, I’m using the lessons I learned in the markets in many other areas of my life. How about you?

Have you learned anything from trading or investing that you’ve carried over to other parts of your life?