US crisis: What investors MUST do and NOT do now

'The whole world is mad. Stocks will be dropping 30 per cent, then rallying 20 per cent, and dropping another 30 per cent -- that's going to be the pattern. And whoever can't live with that shouldn't be buying equities at all.'

These are the words of noted investment guru Marc Faber, the author of The Gloom Boom & Doom Report.

Judging from the way stock markets are reacting these days, it does seem that the world has indeed gone mad.

But, as Faber says, if you can't live with the current uncertainty and volatility in the stock markets, you must not be buying stocks at all.

So the question is, how do you live with so much uncertainty and volatility out there and still keep your otherwise level-headed thinking intact?

. . .

The answer lies in how you manage your emotions while investing (and staying invested) in stock markets.

We have many examples of how people with financial intelligence have fared so poorly as investors. We have also seen the rise and drastic fall of LTCM (long-term capital management).

Let's take an example: of how 'general intelligence' isn't enough to make you a successful investor.

Have you heard of Mensa?

Mensa is a society that limits its membership to people with an IQ (intelligence quotient) in the top 2 per cent of the population.

The only requirement for membership to Mensa is an IQ in the 98th percentile or better (in simple terms, you must be 'super intelligent' to qualify). Currently, Mensa has over 110,000 members across 100 countries.

. . .

So far so good! Mensa is an esteemed organisation, and you would definitely want to be a part of it.

Now take this. It turns out that Mensa has an investment club. Given the high level of intelligence of its members, it can be assumed that this investment club would've had a good history of beating the markets in the past, right? After all, they are the smartest people in the world making investment decisions.

Well, don't draw any conclusions so fast! During the 15-year period between 1986 and 2001 (for which the data is available), the American stock markets (S&P 500) generated average annual returns of 15.3 per cent. Against this, how much did Mensa's investments earn? (Check out the graph to the left)

Just 2.5 per cent per annum!

. . .

Now that would be 84 per cent worse than the index. . . and worse than even the worst of mutual funds that must have operated during that period.

So much for the super normal 'intelligence' of Mensa's members!

Here is what Warren Buffett has to say about IQ and investing: 'Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ .What's needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.'

It's not IQ, but EQ that counts more in investing

Yes, successful investing is all about having the right amount of EQ, or 'emotional quotient' (the measure of a person's emotional intelligence).

This is what Daniel Goleman, the author of Emotional Intelligence, has been promoting since the 1990s -- that success is more closely tied to emotional intelligence than education or knowledge.

. . .

As he wrote in his book, 'As we all know from experience, when it comes to shaping our decisions and our actions, feeling counts every bit as much -- and often more -- than thought. . . Passions overwhelm reason time and again.'

Goleman argues that two key aspects of emotional intelligence are:

• Impulse control, and
• Persistence.

These are exactly the two qualities that will keep you from abandoning your investment strategy in a panic.

Rational behaviour does not cause dramatic short-term swings in stock prices, as we are seeing now.

It is fear and greed, plain and simple.

See, as far as the current uncertainty and volatility in the stock markets are concerned, we're still in the early innings.

. . .

As such, this situation is likely to be with us for a while.

So what does this mean for you as an investor?

It means that to hold your head when others around you are losing theirs, you need to use your EQ, not your IQ.

How to be emotionally intelligent?

Here are three ways you can use your emotional intelligence while investing in stock markets:

1. Have realistic expectations

Stock market is one place where trees are expected to grow to the sky. However, you must resist the temptation (especially during a bull market) to think this way.

Similarly, during panicky times like what we're seeing now, avoid expecting the world to end and the markets to close down. Things always get normal. It only takes time.

. . .

2. Resist the urge to 'do something'

It's one thing to feel fearful about the market. It's quite another to let that fear crush your well-laid investment plans. Resist the temptation to 'do something'.

Resist the urge to push the panic button. Your impatience can turn out to be a bigger disaster for your portfolio than any stock market crisis.

3. Automate your investments

If you're just starting out on your investment journey and have many years left for accumulating wealth, use a discipline like dollar-cost averaging -- investing a consistent amount at regular intervals -- to take advantage of the market's occasional volatility.

A systematic investment plan (SIP) in a good mutual fund can help you do that.

We are humans and thus can't protect ourselves against occasional bouts of emotional outpourings. But it's safe to say that if you let those emotions control your investment decisions, eventually you'll be left with nothing but regret.

So, use your emotional intelligence while investing in the stock markets.

Don't panic. Simply take a chill pill.