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Investing Tips |
Face it. We’ve been looking for a handle to bring you our seventeen years of experience in one paper. We’ve found it under our nose. What you do depends on what you expect. What you expect is based on your perception of the past and present and, to some extent, what others say, rather than a perception of the future based on objective criteria.
A few years ago, we read a book called It’s Not What You Buy, It’s When You Sell That Counts by an analyst at Value Line. The book was all about the psychology of investment. The author focused on his observation that once owned, a security is more likely to be given the benefit of the doubt if difficulty persists. Further, he noted that severe difficulty (price drops) often led to greater commitment, not less. His conclusion was that people get attached to their current course and fear change, even if objective criteria dictate that a change is necessary. Behavioral research has expanded on this observation, and yields insight into guides for financial decision making.
The Journal of Psychology and Markets is an in depth and scholarly look at human behavior in financial transactions. No matter what level one is involved in, at the decision to commit funds to an advisor or an advisor’s decision to commit to a particular security or strategy, the research holds. Interestingly, it holds even through the sell or bail out decisions. Here’s a look at some recent research findings.
Perception of the future is based on perception of the past
Nowhere is this feeling more prevalent than in periods immediately following a major change in market direction. In 2000, most people were in denial about the end of the great bull. In 2003, most people are in denial that the great bear has ended. Unfortunately, the masses of people get in too late or get out too late.
We’ve been discussing investment strategy with many people since the major market lows (in the U.S.) of July and October 2002 and March 2003. The speed at which U.S. markets and most of their world counterparts crumbled from April 2002 to July 2002 created much fear and wariness about investing in general and investing in common stocks in particular. Instead, people embraced real estate because it was something they could grasp and because prices were going up. So many times I heard, “I’ll never touch another stock again.” Just as markets were getting cheap enough to invest again, the majority of people bailed. And they have not come back, either. It remains to be seen whether buying real estate after a big run proves to be a successful strategy in the next few years. We believe that history will again favor a strategy of asset rotation. As it was profitable to rotate from stocks to real estate in 2000, so will it likely to be a successful strategy to rotate (at least partially) from real estate to stocks in 2003.
The experience of the end of the bear market was devastating, and many people were so shocked that all they could think of was the safe money market. It’s perfectly natural to feel fear, but acting with an abrupt change of direction may actually compound poor decision making.
Another way to look at the phenomenon of past perception driving future perception lies in the observation by a Nobel laureate, “Stability leads to instability”. In markets, just as things get really comfortable, people think it will last and bid prices to astronomical levels. Then instability ensues until a bottom is reached. That bottom gets tested repeatedly and the cycle begins over again. Beginnings are often tentative, and tops are seldom marked in terms of days – more like weeks or months.
Conclusion: It is perfectly okay to be cautious when committing to a path. Just be sure to look objectively at future prospects and shed old ideas from the past. It’s about “learning to unlearn”, one of the Thoughts for the Week posted on our web site www.gaiacapital.com. To be successful in just about anything you must discard ideas that are no longer working in favor of those that will most likely work. Otherwise, you are always chasing past performance.
Familiarity breeds poor decision making
A study of German and American investors showed each favoring their own country’s offerings over the others’. Objective criteria did not matter as much as did familiarity. Better yet, as is usually the case, each set of investors chose the particular set of economic criteria which best suited their side and ignored the rest. The arguments for each side sound convincing, but only one can be right.
The key to a solid investment program is to discard old perceptions and look for points where there is likely to be a seed change. Let all of the little wiggles and waggles take care of themselves.
Just as stability leads to instability, the reverse is true. Neither is lasting. In investing, one must grasp this fact to be successful. We’ve long adopted the maxim “buy when nervous, sell when you want to buy more because it just can’t go down.” Now we have the academic reasoning.
Finally – for our clients
We might make you nervous when you see us buying something in India, some gold or anything you are unfamiliar with. That’s the way it should be. Rest assured that we are investing in something that fits your particular tolerance for risk and investment expectations. By the time our selections get to be household names, we’ll probably be out of them. It’s called “buy low and sell high”. You can’t buy low when everyone is chasing.
Finally, a major course reversal in your financial plan should be done with
all of the above discussion in mind. If not, you may well fall into the trap
of hindsight investing. It may feel good for a while, but you may well be better
served by considering all options before you choose a Draconian one.