1888PressRelease – FCFG Senior Client Advisor Steven Brookes Takes A Brief Look At The Effects That Emotion Can Have On An Investor. Below Is A Brief Synopsis.
If you work in the financial industry you will most definitely have heard the old idiom that the markets are controlled by fear and greed. Whilst for the majority of investors this is often true, there is another breed of investor which trades based not on emotion but on emotion’s opposite, logic.
If you are going to invest based on emotion you must first understand precisely what effect fear and greed will have. Below I will look at how the thought patterns that govern investment strategies can affect individual portfolios and the markets as a whole.
The Effect Of Greed
The reason we invest is to make money. It really is as simple as that. The overall objective changes from person to person but in the end it all comes down to a need to acquire wealth. Where a significant number of us will be disciplined and hold on to our goals over time, some of us will succumb to greed and try to reach our desired goals in the shortest possible time frame.
A great example of this is the so called ‘Dot Com Bubble’ in the mid to late 1990’s. With all of the hype around the internet and the wealth of possibilities it could bring to the world, any broker could call an investor and propose an investment into an internet start-up and the buy would be signed and sealed within minutes. Due to the inflated rate at which these stocks were being bought and sold, many of these companies became massively overpriced. This created a false ceiling which could not support the weight of the hype that built it. In the year 2000, as was inevitable, the bubble burst, the internet companies lost their value and the global indexes remained sluggish well into the next year.
This idea that you can ‘get rich quick’ is an appealing idea to anyone but it is an idea that can make it hard to adhere to your long term goals and achieve gains. During situations like this it is imperative that any investor stay the course and adhere to the most basic fundamentals, such as maintaining your long term goalposts, dollar-cost averaging and not jumping on to the latest media hyped bandwagon.
Any discussion on the benefits of not getting swept up in the latest craze must bring with it mention of the so called ‘Oracle of Omaha’, Mr. Warren Buffett. Buffet, one of the world’s most successful investors, was criticized for shying away from the high-growth tech stocks of the 1990’s. Some of his detractors even dared to suggest that Buffet may be losing his edge. All of his critics however, were less vocal on the subject when the tech bubble burst. By sticking with his long term goals, by avoiding emotional reaction to the markets, Buffet was relatively unaffected by the losses his fellow investors felt.
The Effect of Fear
The markets and their inhabitants do not only fall when overcome by greed, fear can also play a major role. Whilst I agree that a degree of caution is a valuable commodity, being too timid can be equally damaging to a portfolio’s performance.
As an example, if a particular stock, sector or market incurs a heavy downturn for a single quarter, this does not necessarily dictate that the following quarter will follow suit. Many investors however will not look deeper into the underlying reasons for the slump, they will see only the negative movements and try to distance themselves as rapidly as they can.
Again the Dot Com Bubble is a perfect example. Just as greed fueled the exponential growth of the tech companies, fear ruled the aftermath as investors tried to limit the losses they were seeing. Seeing equities as too volatile, a lot of investors suddenly reversed their strategies and moved into low risk, low yield investment vehicles such as money market securities, principal protected funds and similar products.
The sheer scale of the shift in investor sentiment showed a complete disregard for strategic discipline. Investors lost sight of their goals, terrified of incurring further losses.
I will agree that your portfolio loosing a large amount of it’s value is going to hurt. But trying to recoup those losses using low return products is a strategy that has little chance of working.
Know Your Comfort Zone
Investing into the stock market carries with it an inherent risk. If an investor fails to maintain their emotional state, and gives in to fear or greed, they leave themselves vulnerable to suffering heavy losses.
Adhere to the fundamentals of investing, avoid being influenced by market sentiment and hold as diverse a portfolio as you can whilst keeping your portfolio in line with your objectives. As an example, if you are a naturally risk adverse person, then consider holding blue chip equities and fixed income bonds, limiting your capital exposure.
Once again, Warren Buffet springs to mind. The ‘Oracle of Omaha’ once said “Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market.”
Bear in mind however, that there is a very fine line between being resolute and being downright stubborn. Whilst it is important to maintain your goals and strategies, it is equally important to be flexible and assess all opportunities rationally.
Conclusion
When it comes to your personal finances you are the decision maker, and as such, you are responsible for the gains or losses you experience.
Adhering to rational investment decisions while remaining in control of your emotions, whether they be greed or fear, and not blindly following market sentiment is vital to successful investing and maintaining a long-term strategy. That said, remember that never straying from an investment strategy during times of emotional volatility in the markets can also be disastrous. Investing is a delicate balancing act that requires a level head at all times.
About the author
Steven Brookes is a Senior Client Advisor at Full Circle Financial Group, Hong Kong. Steven has worked in the financial markets for a number of years for some of the world’s largest and most successful investment houses. His insights are valued by not only his clients and colleagues at FCFG, but from investors and investment professionals around the world.