Over the past few weeks, we have received several e-mails and some letters asking us if the rising stock markets was an indication that they should exit their investments. Some of these people are well educated and pretty articulate about their fears and concerns. It made us wonder what goes into the minds of rational people to react illogically, just because the stock market indices are on the rise. Agreed, money is an emotive subject and the stock markets are a rollercoaster where emotions change based on market movements, impacting investors’ portfolio and their psyche.
We felt, we should explore about what drives investor behaviour as the market changes. Behavioural finance, which applies the study of cognitive psychology to the motives behind money-related decision-making, offers clues to strategies that investors can pursue to proactively direct their emotions toward the decisions that could ultimately be in their best interests.
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Let us go back in time, a little over a decade ago when the Indian markets witnessed an unprecedented bull run during 2004-07. The rise was followed by a drastic fall in 2008. The next five years was a phase of bearish sideways movement, when the indices looked least attractive. The tendency among investors in 2007-08 was one of disbelief, when the market tanked. Several investors lost confidence and exited the market, but are now slowly coming back. It is a different issue that the market rebounded in 2009 and remained sideways in a bearish phase over the next 3-4 years offering investors little to cheer about.
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The human mind is biologically incapable of complete objectivity; every decision is a combination of emotion and reason. No wonder, we tend to be attracted to the markets well after it has gained significantly. According to William Bernstein, an American neurologist and investment author, we like looking for established patterns even when we know that finance is statistically far less predictable. He says that the part of our brain called the amygdala makes us invest based on past information.
It is no wonder then that the flurry of mails is from people who are not sure if the rising market is going to continue its upward trend or if it will repeat past performance to fall and crash. The answer to when the market will fall is something no one knows, just as no one knows if it will continue to go up.
Although irrationality is commonplace, it does not necessarily mean we are helpless. So, how will you know that the investment decisions you make are in your best interests? A way out is to understand your own biases when investing, seek advice from others, use data and take time to reflect before making a decision. Such an approach can form the basis of a powerful, proactive investment plan.
These are times when you may take a drastic step which could wipe out your hard earned money and savings. The mind of an investor is restless and always seeking for something more. As a better investor, you should take charge of your investments or, at least, observe how it is faring and whether it is within the parameters that meet your expectations. Then, continue investing. Armed with these insights, you have all the necessary tools to leave past mistakes behind and make decisions that could ultimately prove rewarding and help you become a better investor to smartly navigate the stock market.
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Keep your emotions in check. It may seem easier said than done, but keeping your emotions in check will lead to personal investment success. So, how can you accomplish this? You can accomplish this by knowing the typical mistakes one commits and what you should be actually doing now. Only you can prevent your emotions from clouding your investment decisions. In the following pages we have listed 14 instances based on which investors could ruin their finances. Identify your emotions before you act on them, and take time to think things through before jumping on an investment decision. Educate yourself.
