There are always a lot of misconceptions about investing and I believe the reason is because our brains were not wired to do investing properly. Well, our ancestors survived by running away from tigers and living cooperatively in a group, and not to analyse an investment logically.
We are full of biases – overconfidence, availability, anchoring, mental accounting, loss aversion and more. Read here and here.
Sometimes it is hard to know if we are falling into biases or disadvantageous thinking when we think about our investments. So I would like to highlight 3 common things said by investors and explain why I think they are problematic.
“I don’t want to invest now because the market is too high. I will buy when it crashes.”
This is perhaps the most common response from investors – the market is too high. It looks harmless on the surface and even conservative in behaviour – who wants to buy near a top only to see one’s capital get wiped out?
But here’s the problem. The stock market goes up most of the time and the probability is stacked against someone who has been waiting to invest. The current bull run has been one of the longest in history and I have heard investors calling market tops since 2015! The stocks keep going up while they sit on the sidelines. It gets harder and harder to get in… until they can no longer take it anymore and they jump into the markets at the very last minute only to experience a crash. The trick is to stay invested for the long run and the gains will outstrip the (temporal) losses, and not to spend your entire life avoiding crashes (because you will avoid most parts of the bull runs too). Moreover, you don’t need to invest 100% of your funds. Just ensure a portion of your capital always stay invested!
I think there are at least two biases here.
First, they have loss aversion – fear of losing money. But losing money in the stock market is part and parcel of investing. Even Warren Buffett loses money from time to time. If you don’t want to lose, don’t touch stocks. That said, I am not suggesting you to go the other way to invest recklessly. What I mean is that markets at some point would correct or even crash and you have to accept that. You have to take the occasional drawdowns in order to enjoy the fruits of returns.
Second, there’s overconfidence in their ability to buy at the low. Case in point, take Covid-19 – we experienced the fastest stock market crash in history. There was a lot of fear going on. But probably most of us have forgotten because the market has rebounded by a lot. Below were some comments we received during the Mar/Apr 2020 period:
“This type of market GOD also can’t help you. DON’T SAY THE ORDINARY PERSON.”
“At this moment don’t buy anything is gaining, cash is king.”
“Reits can be defaulted and run into insolvency.”
You can sense the dismay and smell the fear. The irony is that some investors have been waiting for the crash and when it comes, they were too afraid to buy. All the waiting has gone to waste. All the opportunity costs were incurred.
“It is too expensive now, I will buy it when the price goes down.”
This is another common phrase sprouted by investors which is similar to the previous statement. The difference is that this is more specific to individual stocks.
We all have our favourite stocks (this can be a confirmation bias) and they may not be trading at the right prices. So we wait. It takes a lot of discipline not to FOMO (fear of missing out) as the prices go higher while we wait.
And suddenly, bad news strike and drive the share price lower to a level that they said they would buy. But stricken with fear, they froze and did nothing. They play the doomsday scenarios in their heads and scare themselves. Here is where recency bias come into play – investors extrapolate recent events and blow them out of proportion.
The thing is lower stock prices are often accompanied by bad news. You can’t really have one without the other. If you want to buy your favourite stocks at lower prices, you have to be prepared that bad news will come. Evaluate if it is a temporary or permanent impact. If it is the former, act with courage. Courage is not fearlessness. Courage is the ability to act despite the presence of fear.
They shun the stocks they said they wanted to buy when the prices were right. But they never do. And when the share prices recovered and gone higher, some will sense regret saying, “aiyah, I should have bought ah” or become more defensive, “I knew they will pull through the crisis.” Don’t say it. Do it.
“I think this stock has great growth prospect, I am invested for the long term.”
We all have heard investors saying “this is the next Google” or “Tesla is going to disrupt the car industry“. Nothing wrong with such calls as long as they are well thought through and investors genuinely have that conviction.
The problem comes when the investment decision was actually influenced by the recent favourable share price movements but was disguised as analysis. They buy the stocks and were happy seeing the gains come through. This reinforced their beliefs that these are great stocks.
But the stock market doesn’t go up in one straight line. There will be corrections at times and bad news will surface. The stocks take a dive and most of the profits were wiped out. The fear creeps in. The worry dawns. The doubts appears. All the ‘what ifs’ scenarios get played in the heads.
All the thoughts about long term investing and the great growth prospect have diminished. All they can see now are the sea of red in their portfolio. All they are concerned about is how much more can they lose.
The only thing that can save them from such worry is conviction. If they bought stocks which they have strong conviction in, they wouldn’t flinch much when the market crashes. It is only when they bought stocks frivolously, thinking of making a quick buck, speculating, then they would really be worried being caught in a bear market. Investors can get away with the latter most of the time as the stock market goes up most of the time. But once in a while they get caught big time.
Investors are not short of stocks to buy. Many are seduced by recent gains rather than high conviction buys that are built through careful study of the stocks. You can be lucky once or twice but not always. The market always catches you one day.
Peel the onion
I tried to go deeper into the driving forces of investor behaviour and their sayings in this article. Human behaviour is like an onion. You can keep peeling and you realise there’s something deeper that is driving the behaviour.
I have come to know that there are at least two worlds. One is the real world. The other is our depiction of the real world in our heads. The former is always right while the latter is full of errors. Investing is about seeing the real world as it is and adjust our versions of reality as close as possible. Easier said than done. But at least I hope these 3 behavioural analyses can get you started.
Well expressed Alvin