Most people think that investing is all about economics.
Like what are the best stocks to buy, when and where to buy
property or where to park one’s money for the best rate
of interest? Only too often, nothing could be further from
reality.
Emotions rule the day!
Saving and investing should be based on a sound understanding
of the economics of the capital markets and an application
of strict self-discipline in order to achieve personal financial
objectives. But why do so many people fail? The reason is
that human beings systematically depart from economic theory
when under pressure. That pressure could be anything from
peer pressure (‘were all into gold at the moment; we’ve
doubled our money in three years. Haven’t you bought
any?’) to family pressure (‘That was a crazy investment;
it’s already lost us 20% - get out of it as quickly
as you can!’).
Winners and losers in the stock market game
Perhaps the world’s stock markets provide the best examples
of investment psychology. One of the richest men in the world,
Warren Buffet, achieved success and shared it with others
through his Berkshire Hathaway investment company by the diligent
study and analysis of companies before deciding which shares
were the best to buy. He then stuck with his purchases for
as long as was necessary to achieve a significant profit,
at which point he would sell them. Seeking value and staying
the course was the hallmark of his success. The average human
being would also like to become rich like Warren Buffet, but
the average human being unfortunately does not have the same
skill set or self-discipline to make it to his level. When
stock markets are booming and daily record highs hit the headlines
(as they have been recently) those who are not in the market
want to be part of it and invariably jump in at this point
in time. What happens next is that the market falls, sometimes
a long way, the new investor panics and sells. The depleted
capital goes back into the bank and the investor becomes a
permanent enemy of the stock markets.
Is this an isolated story?
Far from it. I have spoken to literally hundreds of people
who have lost money or had a bad experience through investing
in the stock markets either directly or indirectly through
mutual funds. I read a story a few years ago of a large successful
fund that had risen around 80% over a five year period. Yet
the majority of the private investors who invested in it during
that period lost money! How could this be? It all comes down
to timing and human weakness. When markets are low and getting
bad publicity no-one wants to buy and those who invested when
they were higher feel badly about their holdings and have
a natural wish to get rid of their holdings, even though they
will lose money. But when markets are high everyone wants
to share in their glory and feel that they too have a successful
investment – whatever the cost! So what people are doing
is buying high and selling low – the opposite of what
they should be doing if ever they are going to make any money!
The same applies to other assets
It’s not just the stock markets where people lose money.
Peer pressure is another factor that persuades people to jump
on any bandwagon that appears to be successful. Usually they
jump on when it’s already overloaded and it’s
just a short time before it tips over. The real estate market
is another example. It cannot be denied that as with the stock
markets, real estate is an asset that has grown exponentially
in value over time. People who have made rational, long term
decisions and have stuck with their investment have done fine.
But others who missed the boat at an early stage often panic
later and buy at any cost when prices are clearly ‘over
the top’. This is a global phenomenon and we periodically
see repossessions and negative equity situations in the US
and Europe when the downturn in the cycle comes around. Logically
it seems absurd to pay top dollar for an apartment in Jakarta
when there is such a massive oversupply of units. Similarly
is it logic or emotion that drives foreigners who fall in
love with Bali to buy the first overpriced villa that is offered
to them? It is emotion of course. The economic reality comes
later.
So what is the answer?
Basically you should stand back emotionally from anything
to do with investing. By all means allocate some ‘emotional’
money for things like holidays or things that add to your
enjoyment. But for big items like real estate, retirement
plans and other financial investments you must look objectively
and seek impartial advice. In the case of real estate, research
the market, look for comparisons, find out how easy it is
to resell and at what price. Take your time to look at different
areas and find out where people like yourself tend to live.
Shop around for the best value and don’t be afraid to
ask for discounts. This is Bali! In the case of financial
investments, retirement plans etc. don’t rush into the
‘flavour of the day’ or allocate large sums of
money to ‘unconventional’ investments that you
don’t fully understand. Don’t undertake a long
term savings or retirement plan unless you really mean to
keep it going until maturity.
But don’t go to the other extreme!
At some point you have to make decisions in life. Don’t
let the ‘psychology of fear’ prevent you from
taking the plunge. Leaving your hard earned gains in the bank
can be as bad as investing them unwisely because dead money
in the bank never grows in real terms. It’s just a matter
of separating emotion from economics. Once you have made a
successful investment based on economics you can then give
vent to your emotions!
Colin Bloodworth is a senior adviser with Financial Partners
International. The opinions expressed are his own. If you
have any questions related to personal finance you may contact
him at 021 520 8099 or colin.bloodworth@financial-partners.biz
