23 Oct Beating Investor Psychology
George Soros once said, “If investing is entertaining, if you’re having fun, you’re probably not making any money. Good investing is boring.”
Investor Psychology is about the behaviour of investors; what they believe, how they act, what they do both in times of the bull market and bear market.
For most individuals, especially in South Africa the word investing in itself is not understood very well. I have had clients before who would ask me, “so if I invest in this, how much interest can I expect”! Clearly never having made the distinction between saving (traditionally in bank savings products) and investing.
Because of this lack of understanding, investors make really expensive mistakes while they are investing. It was American economist Eugene Fama, who argued that stocks always trade at their fair value, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices, yet studies into behavioural finance show that emotion and psychology play a role when investors make decisions, sometimes causing them to behave in irrational and unpredictable ways.
The most common investor psychology traps:
- Investors think they can time the market
Greet and fear drive investors who think they can time the market. Greed in that, if they think they have some superior knowledge whether true or false, they will stay invested for much longer than the information holds true. Fear in that when some investors hear of a recession, a bear market or tough economics times, they pull back on their investments. An investor who times the market is really just a speculator, they are not in it in for the long haul, and they want the quickest way to make a profit
- Investors buy expensive stocks
We have all heard the story, a couple of friends around the braai, talking about what share is doing well on the stock market; how they have had a lucky break because of their stock choice. Much like pyramid a scheme, if everyone is talking about it, you are probably late to the party! This is because of the “herd mentality or pack mentality”, where people are influenced by their peers to adopt certain behaviours on a largely emotional, rather than rational basis.
- Investors sell in panic in a bear market
The temptation to get out of the stock market when things are not going well is huge. It is human nature to try by all means to avoid pain and bad experiences. That behaviour is no different when it comes to investing. When an unseasoned investor experiences loss, they tend to panic, sell at a loss and retreat from the financial markets.
Recently at the Alexandra Forbes Investment Indaba, financial writer and author, Morgan Housel highlighted and illustrated the Investor Psychology phenomenon. His talk showed that people cannot accept simple truths; they want what looks complicated and seemingly complex and challenging, therefore making it worthy of success. In the example he uses Warren Buffet, one of the world’s most success investors, whose simple philosophy is he invests in businesses he understands,
he ignores short-term market volatility and focuses on long-term returns.
Most individuals and investors expect about investing is that it will be complicated, high tech and almost not within reach for the laymen. When they think of investing they picture multiple trading screens and fancy algorithms. While the picture does bear some truth about investing, many successful investors have done well without the multiple screens and seemingly complex technology around investing.
To sum up, individual behaviour has a lot to do with investment returns; take for example, “Julia”, a middle-class woman who is a frequent guest on The Money Show on 702 with Bruce Whitfield, with her middle-class income, lots of discipline and guidance, has build a very impressive investment portfolio.
The takeaway from her approach is discipline, know why you are investing and even in the tough times keep on investing. Do not withdraw or exit from the markets. Although it is human nature to want to!
This article first appeared in City Press.