Have your emotions become over riding decisions for your investments ? In 2011, when the stock market was going down south, did you buy or did you sell ? If your investment behaviour or decisions were based on sound principles, then you might be on a strong footing as far as your financial planning goes but if they were based on decisions driven by your heart, you might be one of those who takes emotional investment decisions.
Behavioural finance is a subject of intense discussion especially in the field of stock market. History has demonstrated that every time there is more money to be made or lose, the decision has been made by the heart and not the head.
Emotional issues and investment behavior
Only a very small percentage of investors do their own research when it comes to buying a stock – all the others either listen to their colleagues who recommend tips or to TV channels where paid news find its way each morning.
Careful thought needs to be given to the source of the information. In the above case, both cannot be relied upon, yet one buys because someone else did. The thought process here is – both of us will either make tons of money or go down together – I am not alone !
Investment logic takes a back seat and emotions drive investment behaviour or decisions.
A stock’s past performance and stupendous growth always sticks to one’s mind. After forming an opinion about an investment, investors seldom change it. Even though there is new information that can be critical to the performance of the stock in the long run, it is overlooked.
So Reliance Industries and Infosys made millions for many investors over the last 10 years but they cannot continue to keep doing that consistently year on year. Yet investors are convinced that any under-performance by companies will not impact their stock price as it was a gem historically. So they don’t sell or get out of the counter and over a period of time, the stock price falls in value eroding the corpus.
Investment behaviour of investors get them attached to investments and even to products – to our house, car or even our cell phones and we end up holding the investment or the product longer than we should. They begin to value things they possess, even if that investment or product, holds little value.
I had a client recently who came to me with a stock portfolio and said he needed me to get rid of stocks in such a way that his portfolio could return 25% each year – of the stock he wanted to retain, his argument of the case was that they had performed well in the past, many of his friends had it and they were big companies. My argument was – so was Lehman and Satyam once upon a time. My client was married to his investments !
Investment Behaviour in Profit and Loss situation
Consider losses that you are sitting on today. You are probably not selling because you think the losses are very huge. Your inaction is not going to move the stock up. Not in the next quarter or year – for all you know, the ticker will only go down. Losses hurt and investors cannot stomach that and so they hold on thinking they will make up for their losses in due course of time !
Same is the case with profits. You might have set a target price for the stock. But when it reaches that figure, emotions take over. You think you might have set the target price too low. Greed takes over and you think there is more moolah to be made. You don’t sell. And then one fine day, the price crashes to such an extent that you lose whatever you were making.
When the market is on an upswing, you believe in your stock picking capabilities and end up buying more units. The fallacy here is that you are buying high. Should it not be the opposite ? You need to probably sell some units of the stock to make profits. Or bring your asset allocation back on track.
Investors also don’t want to tread on things they cannot understand and either disregard that piece of information or discount it.
Honestly, investment behaviour won’t change investor’s biases very quickly. They need to adopt some strategies to get in and out of stocks. Will power and the ability to stick to targets is what will drive overcoming such biases. So when you buy a stock, set a target and sell when you reach that. Put triggers on the downside so that if the price crashes, you can get out to limit your losses.
Last but not the least, picking the right stock is something that is a huge field. I don’t think many of us can master it in a lifetime. So know the risk of investing on tips and use the above buy and sell strategy to invest in stocks.
Take a poll on emotional issues and investment behavior.
@Radhey,
Excellent article. Emotions play a very big role at least for me when i invest in stocks. I am still holding to some dud/laggard stocks from 2008 crash with the hope they will go up one day. They are still 50% down from 2007 levels. If i had sold them and invested in some good blue chip stocks i would have recovered my money.
As for profit booking, now i follow a very strict principle of booking profits at every 10-20% rise. Even though after selling a particular stock it has gone 25% up but that does not hurt me anymore. I am learning to control greed.
@rakesh, That is very good principle if you are able to stick to it. People dream about 50-100% returns from stocks, which is not realistic. 15-20% is a realistic goal and if one sticks to it, half of the problem is gone.
@rakesh, So Rakesh, if you know this, you could have got out earlier or even now ?
Believe me, it takes the guts just once after that you can take losses as it comes.
You do it once and then you can take the losses in the future, right ?
I like you profit booking strategy and I think everyone should stick to it.
Sir
The Article is very nice and well applicable to me also
i m still holding stocks that are more than 50% down from purchase price and i m holding these stock since last so many years being a long term investor…..but nothing happened
by the way i have added your site to my blog http://www.experttricks.blogspot.com
pls visit
@Sushil,
We are in the same boat, very difficult to control emotions and greed. I did have the courage to sell some stocks at 40% down and switch over but i have still hold on to few. Once market gives an opportunity i will sell more of those laggards.
Not sure when market would give the opportunity to sell Rakesh, let us wait and see. What are the levels in your opinion ? Sensex at 20,000 ?
@Sushil, Have you considered selling your stocks at loss and reinvest the money somewhere else?
@Sushil, I really like your blog Sushil, everything under one roof. That’s an innovative thought! I am sure it is helpful for many readers who are in search of various articles. I shall keep visiting it.
The name is also appropriate especially the one on the page “Copy n Paste”. 🙂
Long term investment does not mean that you hold onto your losses sir.
It means that you cut your losses and get out of it and move forward. Requires a lot of courage but worth it I guess.
When I was investing in stocks I was an emotional buyer. I never did any research and bought exactly because of the reasons mentioned in this article. The reasons were the company name is big, my colleague bought it, my wife’s broker recommended it and she made profit once upon a time.
As a result today my overall stock portfolio is -45% and none of the stocks are in positive. The biggest loss is as huge as -75%. I am not a person who can bear big losses and reinvest somewhere. So for now the money is just sitting and I occasionally watch it and remember my stupid emotional decisions.
I am sharing my experience so that the readers can see the outcome of emotional decisions when it comes to investing money. One should always always do proper research before investing into anything be it buying stocks, MFs, insurance etc otherwise one day you will repent your emotional decision and trust me no one will be spared.
Now I have become very cautious and never buy anything without understanding the product. Investing in equity is important to me but buying stocks require lot of time and energy, which I don’t have so I am sticking with MFs. Even that I don’t buy just based on tips, I do my research and ensure my head is convinced to buy that MF.
Vivek, I don’t think it is true when you say you cannot bear losses. I also think it might not be prudent to wait with -75% losses just to break even. That might never happen actually.
I like the fact that you have now moved to MFs, it is the best investing way for retail investors.
I seriously think you should move out of the losses you are sitting on.
I purchased shares only once and I still hold them.I confine myself to mutual funds.I invested a lot in mutual funds last year.I have not exited from any fund so far.
Hi Anil, can you share your experience with shares? How did you buy them and how did the decision turn out to be for you?
Thanks for the advice Radhey. Let me think over and see if I can take the bold move 🙂
@TheWealthWisher,
The original look & feel of the webpage was much better and appealing. This one is ok for forums but not for main articles.
I wanted to give the site a consistent feel – earlier the main site was different and the forums was different.
Don’t worry, like you will begin to like it after you win some prizes here. 🙂
@Radhey,
Hmmm. Yes it will take just few days to get used to the site.
@TheWealthWisher,
Yes i did do for some stocks but then i had hopes and still have that those stocks will go up someday. Nothing wrong with the company but its the management. Anyways i am just looking for the next upmove to sell some more stocks.
20,000 on the Sensex would be a start, Next week onwards we will see companies declaring quarter results and if they are really good we might see a nice rally.
20k on the Sensex, I guess by Dec 2012 ?
@TheWeatlhWisher,
Couple of good quarters and we can have fireworks by Diwali.
hahaha, this is what I always hope when I see my negative stock portfolio 🙂
Looks like we haven’t had a poll for sometime?
3 weeks…..