RULE 4

Conquer the Enemy in the Mirror

My brother Ian is a huge fan of the 1999 movie Fight Club, particularly the scene where the lead character Tyler, played by Edward Norton, is shown throwing haymaker punches at his own swollen face. Norton's character is metaphorically battling his materialistic urges. Most investors fight similar battles in a war against themselves.

Much of that internal grappling comes from misunderstanding the stock market. I can't promise to collar your inner doppelganger, but when you understand how the stock market works—and how human emotions can sabotage the best-laid plans—you'll experience greater investment success.

When a 10 Percent Gain Isn't a 10 Percent Gain

Imagine a mutual fund that has averaged 10 percent a year over the past 20 years after all fees and expenses. Some years it might have lost money; other years it might have profited beyond expectation. It's a roller coaster ride, right? But imagine, on average, that it gained 10 percent annually even after the bumps, rises, twists, and turns. If you found a thousand investors who had invested in that fund from 1990 to 2010, you would expect that each would have netted a 10 percent annual return.

On average, however, they wouldn't have made anything close to that. When the fund had a couple of bad years, most investors react by putting less money in the fund or stop contributing to it entirely. Many investment advisers would say: “This fund hasn't been doing well lately. Because we're looking ...

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