Your in­vest­ments’ worst en­emy

When the bear raises its head, many in­vestors panic and aban­don all ra­tio­nal thought. But it is im­por­tant to keep your emo­tions in check, in good times and in bad.

Finweek English Edition - - MARKET PLACE -

we­often act from the heart rather than the head – much of what we do and how we choose to re­spond to a sit­u­a­tion is based on our emo­tions. This is what makes us su­per-con­sumers – do we re­ally need the new­est car model, cell­phone or pair of shoes? Or do we like the way these items makes us feel? And while emo­tions are part of what makes our life worth liv­ing, they’re not our best part­ner when it comes to mak­ing fi­nan­cial de­ci­sions.

While we pos­sess in­her­ent be­havioural bi­ases based on our emo­tions (for ex­am­ple, how we feel about money, seek­ing fi­nan­cial ad­vice, or fol­low­ing a hot in­vest­ment tip), fi­nan­cially savvy in­di­vid­u­als know that to make wise in­vest­ment de­ci­sions, they need to con­stantly check their emo­tions.

Be­ing aware of these emo­tions is the first step to coun­ter­ing im­pul­sive fi­nan­cial de­ci­sions. Emo­tions like fear and greed, for ex­am­ple, can be pow­er­ful driv­ers when it comes to man­ag­ing your money. Pan­der­ing to these is a sure way to en­sure the de­struc­tion of wealth.

Just like our emo­tions, fi­nan­cial mar­kets are cycli­cal in na­ture. The com­bi­na­tion of these two fac­tors mag­ni­fies the boom-and-bust char­ac­ter­is­tics of these cy­cles, with the bot­tom of the mar­ket most of­ten leav­ing in­vestors feel­ing the most pes­simistic and de­pressed.

Con­sider this ex­am­ple – in 2008, the JSE All Share In­dex dropped over 45% in the six months from May to Oc­to­ber. Not only did this have a huge im­pact on in­di­vid­u­als’ wealth, but it was also an ex­tremely emo­tional pe­riod for in­vestors, with many pan­ick­ing about the state of their port­fo­lios. We should be buy­ing low and sell­ing high, but these emo­tion­ally try­ing times will of­ten make us do the op­po­site.

With the ben­e­fit of hind­sight, this turn of events pre­sented a com­pelling op­por­tu­nity. In­vest­ments in large, rep­utable, multi­na­tional com­pa­nies with good growth po­ten­tial were now on sale at a 45% dis­count – what a bargain!

How­ever, with fear of the global credit crisis as their pri­mary driver, most in­vestors did not buy shares – they sold in­stead. The re­sult? Sig­nif­i­cant losses on their in­vest­ments. If those with the fi­nances to do so had bought rather than sold, they would have ex­pe­ri­enced fan­tas­tic re­turns in the af­ter­math of the crisis. Bil­lion­aire in­vestor and phi­lan­thropist War­ren Buf­fett summed it up best

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