Personal-Finance

Beating the investor psychology

2018-10-05 12:07

George Soros, the Hungarian-American investor and business magnate, 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 is not well understood.

I have had clients who have asked: “If I invest in this, how much interest can I expect?” Clearly they have never made the distinction between saving (traditionally in bank savings products) and investing.

Because of this lack of understanding, investors make expensive mistakes while they are investing.

American economist Eugene Fama 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 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:

1 Investors think they can time the market

Greed and fear drive investors who think they can time the market. Greed because they think they have some superior knowledge, whether true or false, and stay invested for much longer than the information holds true. Fear because when some investors hear about a recession, a bear market or tough economic 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.

2 Investors buy expensive stocks

We have all heard the story. A few friends around the braai, talking about what share is doing well on the stock market, or how they have had a lucky break because of their stock choice. Much like a pyramid scheme, if everyone is talking about it, you are probably late to the party. This is because of the “herd mentality” or “pack mentality”, in which people are influenced by their peers to adopt certain behaviours on a largely emotional, rather than rational, basis.

3 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 Alexander Forbes Investment Indaba, financial writer and author Morgan Housel highlighted and illustrated the investor psychology phenomenon. His talk showed 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 successful investors, whose simple philosophy is that he invests in businesses he understands, he ignores short-term market volatility and focuses on long-term returns.

Most individuals and investors expect that investing will be complicated, high tech and almost not within reach of the laymen. When they think about investing they picture multiple trading screens and fancy algorithms. While the picture does reflect 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, she has built a very impressive investment portfolio.

The takeaway from her approach is discipline, know why you are investing and even in tough times, keep investing. Do not withdraw or exit from the markets, even though it is human nature to want to pull out.

. Makhu is a personal finance coach and columnist

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December 16 2018