In the investment industry, it is seen that investors have the tendency of accumulating investments at the top and selling at the bottom. Many Ghanaian investors buy high when everybody is making so much noise about how good a security is and rather sell when there is a downturn and prices are falling.
They get caught up in media hype or fear and resort to buying or selling investments at the peaks and valleys of the cycle respectively. Warren Buffet well known investors is quoted to have said “Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.”
One would ask why this type of emotional investing happens to investors and how can investors avoid both the stress and depressions of going through this cycle.
Investor Behavior accounts for one of the reasons why people are emotional investors. Over the years, well documented study of investor behavior has tried to explain the reason behind the overreaction of investors towards certain investment periods. It mostly seems like rational thinking flies out of the window when the markets turn volatile. Investors’ psyche overpowers rational thinking during times of stress, whether that stress is a result of euphoria or fear.
The layman or non-professional investor puts his hard-earned cash at stake and while hoping for a gain, wants to protect that cash against losses. Investors get a stream investment “information” from many sources, such as mainstream media, financial news, friends, family and co-workers.
Most investors rely on what they hear from these sources to make their investment decision of when, how and what to invest in instead of learning extensively to acquire knowledge about securities or stocks we want to invest in by themselves. It is quite normal to hear potential investors say “my friend says I should invest in security X because it is very good” without having an idea as to what the stock or product is about.
Investors often also get enticed during the bull market period when prices in the markets tend to go up indiscriminately. They are attracted to the upward trend of prices and rather enter the market buying at high prices.
During such times of market exuberance, investors tend to listen to stories from friends or family members about how much money they are making in the market, creating a stir and compelling those who have not invested to test the waters. It is therefore not surprising to find peoples heart at their sleeves in a hurry to buy into a product or a certain stock because they have been advised to do so by friends or relative. On the other hand, once the products performance or the market outcome is contrary to their expectation, they run desperately to cash out. Be wary when everyone is singing highly of a particular security or stock but rather buy more when everybody is in a hurry sell out.
Investors also time their buying and selling badly. Mostly investors choose to invest in the markets when everybody is doing so. This is because there probably a hype or buzz from the media or the influences around them which causes investors makes decisions based on the opinions of others.
In addition we have to consider that, as at the time when our relatives and friends where invest prices may have been low and only inform us about it when they are making profit due to high prices. New investors now buy in at the high price most likely at a point when the market prices have peaked and can no more increase.
When prices start to take a downward spiral, the quickly sell out to avoid more losses when rather this is the time to buy more into the market. Market uncertainty creates fear and brings about an atmosphere of emotional investing.
Here in Ghana, the media does not often play too much part in market trends. But when investing other market especially the developed market, media tend to play a large part influencing the public.
By this their role, there is sometimes a lag between when an event occurs and when it is reported and this what typically causes investors to lose money. The media will report a bull market only once it has already hit. Unless the trend continues, stocks will retract in upcoming periods.
Investors, influenced by the reports, often choose these times of high prices to build up their portfolios. It is worrisome when the daily stock market report leads off the mainstream news because it creates a stir and investors make decisions based on “opinions” that are often outdated. Therefore those who rely only on market updates from only the media are at risk of becoming emotional investors.
Taking the Emotion Out of Investing
Know yourselves. Investors should know themselves first and foremost. Knowing your risk profiles aides investors in choosing the best investment vehicles to invest in. by doing so, the investors quite confident in whatever sector they place their investments or funds thus during volatile times they can rest knowing that their investments are secured.
Following this is knowing more about investments. Most individuals fail to do due diligence to the investment vehicles they choose to invest in and fail to study the market trends. Acquiring extensive knowledge on stocks or securities that one is interested in investing in helps to choose appropriate vehicles to invest in. It saves investors the stress and euphoria they experience during volatile periods.
Investors know the nature of these investment tools and are prepared for fluctuations that may occur. For instance and investor buy into the stock market would have at the back of his or her mind that stock prices may fluctuate from time to time due to market conditions, the economy, management and policies of the company or any other factor that may account for price change therefore in times when the price of a stock is dropping the investor will not be agitated and in a hurry to sell off their stocks at the falling price but will patiently wait the period out.
Adding to the above point using buying stocks as an example, knowing the nature of the investment vehicle you are choosing helps one to know when to buy and sell stocks. Having adequate knowledge of market trends will help to buy when prices are low and selling when prices are high which, is usually the opposite of what happens.
Properly timing your investment is also key in avoiding emotional investment. When you know when to invest you avoid the stress that comes with the uncertainty. It is worthy to note timing as well as patience is everything in investing. Also studying the bull and bear markets because evidence suggests that emotional investing gets the best of the typical investor during periods of uncertainty.
The most effective way to avoid emotional investing is to do a cost averaging investment. Cedi cost averaging is a strategy where equal amounts of money is invested at regular interval for instance, investing GH¢100 every last day of the month.
Investing in certain mutual funds or joining investment clubs gives us the luxury of using this strategy most of the time. What makes this strategy good during all market condition is that, during a downward trend, investors are purchasing shares at cheaper and cheaper prices thus during an upward trend, the shares previously held in the portfolio are producing high capital gains and fewer shares are being added at the higher price because at the same price of Gh¢ 100 less shares can be bought. The key to this strategy is to stay the course- set the strategy and don’t tamper with it or break the investment unless a major change warrants the use of your funds.
Finally diversification is another technique to consider. A way to diminish the emotional response to market investing is to diversify a portfolio as the golden rule of investment state “do not put all your eggs in one basket”. Diversification provides protection for investors when there are mostly market downturns.
Mostly in the market cycle when stocks start to suffer in a downturn, fixed income securities usually do well and when there is some stability and stocks tend to do better. In most normal market cycles, the use of a diversification strategy provides downward protection. Diversifying a portfolio can take many forms such as investing in different stocks in one market, different industries, different geographies, different types of investments and even hedging with alternative investments like real estate, private equity, foreign currencies or precious minerals. There are distinctive market conditions that favor each of these subsectors of the market, so a portfolio made up of all these various types of investments should provide protection in a range of market conditions.
Investing without emotion is easier said than done because we are emotional human beings and emotions will always come to play because uncertainty rules the market and the media. Evidence suggests that most investors are emotional and maximize money flows at the wrong times; this is a sure way to reduce potential returns. Strategies that eliminate the emotional response to investing should produce returns that are significantly greater than those indicated by the typical investor responding to the market rather than proactively investing in the market.
The strategies above are effective ways of diminishing emotional investing rather than the approach that the layman may choose to use. Money is difficult to come by and even more painful to lose when you expect growth so let us all choose to stop emotional investing and do our homework well when starting an investment.