It turns out, however, that this is the wrong way to think about the issue. Much like the data on an old disk drive, studies show that bad habits never go away, or at least not entirely. Instead, they can only be overwritten by better ones. Psychologists refer to this as “habit reversal” — sounds Orwellian, I know.
A habit can be broken down into three distinct parts, which together form a “habit loop.” First is the cue, which triggers your brain to initiate the loop — say, watching CNBC or reading an alarmist headline. Next is the routine, which consists of the behavior itself — for instance, selling a stock in panic based on what you just learned. And finally is the reward — in our case, the rush of relief that comes over you after the trade.
With this in mind, the objective isn’t to eradicate the entire habit loop, but rather to identify the cues and rewards and then swap out the undesirable routine for a new one. “That’s the rule,” Duhigg explains, “if you use the same cue, and provide the same reward, you can shift the routine and change the habit.”
So how does this translate into better investing? If there’s one thing we know for certain, it’s that frequent trading is, to put it in the words of the seminal study on the issue, “hazardous to your wealth.” As the authors show, investors who traded the most ended up underperforming the S&P 500 by more than six percentage points per year.
“That’s a staggering amount,” my colleague Morgan Housel pointed out. “Over time, it’s the difference between a good retirement and no retirement.”
The trick, in turn, is to trade less frequently. One way to do so is to avoid cues that lead you to do so — watching CNBC, for example. The other way, as I’ve discussed, is to swap out the old routine in favor of a new one — that is, use habit reversal techniques.
I recommend the latter. And, more specifically, I recommend that you bookmark this article on discipline and successful investing and reread it as your routine every time you’re confronted with a cue to impulsively buy or sell a stock. I can almost guarantee that doing so will save you money and increase your returns.
The article Good Habits Make Great Investors originally appeared on Fool.com and is written by John Maxfield.
John Maxfield has no position in any stocks mentioned. The Motley Fool recommends and owns shares of TD AMERITRADE.
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