The recent market slide and the tech-wreck has left me wondering – Why do so many investors (and fund managers too) repeat the same mistakes time and again? After listening to many of the regret stories, the reason was not difficult to decode – almost every investor allowed his emotions to precede his decision-making. And every story has identical theme -- investors becoming over confident and unrealistic with their expectations.
I have been following the day to day gyrations of the market to gain understanding of market trends and behaviours. The more I observe the more convinced I am, of the utter irrationality of many of these spasms. Few days ago, every sector of the market gained 1-2% in a single day. The next day, everyone was worried about the interest rates again, erasing the previous day's gains. How can the picture change so much on a day to day basis? What other factors are at work here? Are stock traders really as emotional as the market news reporting seems to imply, with all of its language about "fears" and "hopes"?
If most of the intra-day trading decisions are really as mercurial as they appear to me, I was wondering about new forces affecting the behaviour of investors and the market other than greed and fear, which have been around since the dawn of mankind. But emotion prevails as the key driver.
The loud noise created by the media (the crawling ticker through the day and live market commentary on television) leaves many investors regretting over missing a high-flying stock. We hear our co-workers bragging about minting money in the market rally. And curse our bad luck for having missed the trend. But those investor's who feel they missed out, also don't take the time to identify the up-and-coming stocks or investments themselves? Most of them allow their fear of missing out and their greed to catch up, move to the next dangerous step of acting on a "hot-tip."
Just because a friend or relative had hit the jackpot previously, doesn't prove their magic touch for times to come. Second, by the time most tips reach you, they're old news. Third, and most important, by following a tip you let your emotions sabotage a sound financial plan.
The other mistake investors make is chasing previous top performers. Eyes get big when you review the enormous percentage gains of the 1999-2000 winners. And the concern is that the best stocks, funds or sectors of the prior year often persuade people to climb aboard. Again, the fear of missing out and the greed of catching the bus, overrides sensible investment decision-making.
Did you hop into the series of Technology Funds launched in February this year? Did you think this sector was unbeatable based on past returns and media hype? Of course, Technology funds were the biggest success stories. And then there's the "can't lose in IT" crowd. How many people chose these funds to represent the bulk of their portfolio, that is beaten down so badly too soon.
A third disturbing error that emotionally charged investors make is falling in love with their investments. Undoubtedly, long-term equity investment is handsomely rewarding. Maybe you have owned a fund or stocks for many years. Perhaps the fund was a winner for five years, but in the last three, it doesn't even keep pace with its Value Research's Fund Average. Or possibly, you can't stand the thought of taking a loss, determined to break even.
Despite the obvious need to sell your lemon, cut bait and get those proceeds in a higher value alternative, the average investor buys-n-holds at his/her own peril. On the other hand, smart investors set their objectives from individual investments and understand under what conditions they will sell.
There's nothing wrong with expressing our feelings about investing, so long as they don't interfere with the decision-making process. Celebrate, mourn, fear, get greedy. But avoid these things until after your decision to buy, sell, or hold has been made.
The best minds all seem to come to the same, simple conclusion when it comes to the best way to invest - pick an allocation, invest you money with clearly stated objective, track it periodically and over the long haul you'll do better than 90% of the money managers. Do your job, open a business, or use your time any way you want. Just invest your money, leave it alone, add to it regularly and let it compound. This is vital stuff we should be taught in our schools, as we are too soon old and smart too late!