Every investor should be aware that their investment decisions have both a financial and emotional consequence.
The axiom that fear and greed rule the market is true. When markets are volatile, investors can be vulnerable. Emotions such as fear, panic, capitulation, depression start to surface. Many investors believe they’re better than actually they are. There is an old saying: “Bulls make money. Bears make money. Pigs get slaughtered”. Emotions override vital factors in the investment decision process, like logic and common sense.
Fear and greed hurts
Extreme fear hurts your portfolio. In such territory, parking your funds in overly conservative investments runs the risk of your returns not keeping up with the pace of inflation, which essentially means, the capital can erode. This was prevalent during the Great Depression and the financial crisis in 2008.
Extreme greed, at the other end, also harms. By chasing ‘hot stocks’, you end up buying at wrong time. Investing logically for the long-term but overreact to short-term emotional decisions. Investors tend to be excessively enthusiastic about investing in stocks when the market is doing well, and then they become unduly pessimistic during bearish spells, eventually pulling out of the market.
There are two types of fear — fear of losing your capital and fear of underperforming the market or your peers. Similarly, the two types of greed include the greed to keep the capital safe and the greed to make more money. Alas, in stock trading, many have a split personality — logical vs. emotional.
‘Buy low - sell high’ is nearly impossible if you let your emotions control how you invest. If you are not able to cope with volatility, then try to build that reality into your investing approach. When the going is good, offload your holdings that have appreciated your capital without allowing sentiment to rule your moves. Recall the time when you made an investing decision that led you to regret. What caused you to react the way you did? Perhaps lack of knowledge, bad timing or letting your emotions run amok.
You are not alone, there are solutions: Have a long-term plan: It is always prudent to remind yourself that any investment plan in which you put your money must work long-term and should be linked to your (retirement) objectives. Define your goals and risk tolerance. Use an investment check-list, to help stay grounded. A simple way to curb emotional investing is to employ the concept of rupee-cost averaging. A steady, consistent strategy like Systematic Investment Plan (SIP), is critical to long-term success. Discipline is the antidote to the emotions that drive your investing astray. Most investment advisors while talking about “staying the course” during a market down-trend, paraphrase the importance of maintaining a long-term outlook.
Stay diversified: Diversify your portfolio into other asset classes such as fixed instruments, gold, real estate, mutual funds, among others. This method may produce a superior risk-adjusted return relative to an equity-only investment portfolio. Have realistic expectations, in line with your risk tolerance level.
Track progress on a schedule: Review your portfolio regularly but not frequently; if necessary meet your financial adviser twice a year, which will help separate you emotionally from swings of the market.
Don’t challenge the market: Make sure you’re investing smarter rather than playing a buy-sell game. Don’t chase returns. Avoid overreacting when the market starts to move. Don’t underrate the effects of emotions. Market down-turns can upset your health when emotions run high.
Look at the bigger picture: Responding to every fluctuation is focusing on the small picture. Changing your investment positions based on emotions can be costly and counter-productive. The frequent activity tends to run up commissions and other transaction costs. Better, rivet on the larger picture.
Stay disciplined: The stock market delivers attractive long-term returns to investors who are disciplined enough to stay fully invested and weather the volatility inherent in the market. Discipline is defined as “doing something you may not want to do, in order to reach a certain goal or desired outcome”. This concept applies equally to investing.
In the words of investment maverick Warren Buffet: “Be fearful when others are greedy, and be greedy when others are fearful”. A good advice, often ignored.
(The writer is a former banker)