If you think successful stock investing requires in-depth knowledge of finance, understanding annual reports and analysing financial statements, think again! What about the role of greed and fear, the two dominating emotions that rule the stock markets and stand like a rock between the investor and success, which remains elusive as ever?
Warren Buffett, a legendary investor of our times, has given a simple formula to beat markets – “Be greedy when others are fearful and be fearful when others are greedy”. What Buffett means is to buy low and sell high. Sounds like common sense. Yet, most investors tend to do the opposite.
Why is it difficult to follow such simple and sage advice? The answer lies in the psychology of investing. More specifically, it is the cognitive bias that is at play. This bias can change a person’s beliefs, opinions, attitude or behaviour because others around him are doing so.
This phenomenon is known as the ‘bandwagon effect’ or ‘herd mentality’.
Humans, as species, have always found comfort in being in a crowd. Our ancestors, when they lived as tribes, always moved in large groups to protect themselves from attacks by hunters and slayers.
Now equate this with the stock market, which is considered risky because of price fluctuations simultaneously caused by factors at play. Many investors, including experienced ones, find navigating the ups and downs difficult. In extreme situations, logical and rational thinking gives way to emotions of greed and fear, which eventually leads to wrong decisions. Therefore, most investors find solace in following and doing what the larger investor fraternity is doing. They simply hop on the bandwagon, which gives them the comfort of being together. The old wisdom – wrong doesn’t become right if accepted by a majority is quickly forgotten.
But then, how do we refrain from joining the bandwagon and keep our sanity and the value of our investments intact? Here are a few guideposts:
Never ignore your asset allocation
You must always follow your asset allocation like the GPS that guides us to our destination. It is the only tool that allows you to buy low and sell high. Rebalancing your asset allocation regularly takes the emotions out of investment decisions.
Avoid the crowd; walk alone.
Cut down on the market noise in the form of tips from friends or the hot market trends going viral on social media. The final decision about any investment should be yours and yours only. Have the courage to walk alone; you must rely on your judgements to scrutinise any investment’s suitability.
Do your homework
It’s always advisable to reach out to your financial advisor for a round of discussion before taking any investment decision. If the logic of your financial advisor doesn’t appeal to you, keep probing till you are satisfied. Do your research before you take the plunge. This is not difficult in today’s era of information.
Only when investors realise that the journey of stock investing is a solitary one, that every investor has a different destination to reach and therefore follows a different path, will they meet success which may otherwise remain elusive forever.
Source: Economic Times