21 December 2018
Christmas is almost upon us. For many, it is a time of buying presents to give to our loved ones and close friends. CNBC recently reported that Christmas holiday retail sales in the U.S. are expected to climb above the US$1 trillion mark for the first time this year, with other analysts expecting the average US consumer to spend some US$794 on Christmas gifts.
For investors, there is also a “sale” in stocks, although that has not brought on as much Christmas cheer. How much is the discount? The product “Global Stocks” is now on sale for 9% less than at the beginning of the year, while “Asia Stocks” is going at a 15% discount.
Yet you don’t see investors rushing to pick up these stocks on the cheap. Why is this so? An Apple iPad or Macbook at such discounted rates would see a stream of ready buyers, even with the knowledge that the product’s value starts to steadily depreciate the moment you buy it. In comparison, stocks have no expiry date, no built-in obsolescence, and prices have been going up for over a century. So it’s strange that when they go “on sale”, investors instead panic and start dumping their inventory. What’s the logic behind this?
In Daniel Kahneman and Amos Tversky’s seminal 1979 paper, Prospect Theory: An Analysis of Decision under Risk, they found that people make seemingly irrational decisions when under pressure. One of the findings was that most people experience something called loss aversion. The unhappiness they feel at losing $100 is greater than their happiness at gaining $100. So, in a way, stock market sales work opposite to retail goods sales. Our mind has an anchored price in mind – say, $500 for a branded handbag. If it is offered at $300, we automatically think we have gained $200. But for financial markets, we don’t think in the same manner. If a stock is trading at $100 and then suddenly drops to $80, for some reason our minds don’t see a gain of $20. Instead, we see only loss, and assume that stock would drop further or even go to zero.
These psychological biases and how they impact investors have been researched in the burgeoning field of behavioural finance. Common investor behavioural errors also include a lack of diversification (betting all one’s money on one horse), compulsive trading, buying high and selling low, going by gut feel, listening to the wrong advice and being affected by daily data.
Interestingly, these investment errors typically affect men, who suffer from overconfidence and very often attribute investment success to their own skill – rather than fate or luck.
Volatile periods in markets, such as what we are now experiencing, always surface the wrong type of emotions in investors. Very often, they end up selling when markets are falling and buying when the markets are going up. What is surprising is that the more well-informed and sophisticated an investor is, the more likely they are compelled to try and finesse their exit and entry points. Studies done by Ledbury Research in a Barclay’s Wealth report found that affluent investors believed that they had to trade more and practise market timing in order to achieve better investment results. The report also found, paradoxically, that those who traded often knew they were trading too much, but were unable to control themselves. Trading was addictive to them.
So, what can one do to keep such emotions in check?
Firstly, remember that falling markets (and rising markets) are a normal part of the investment cycle. One shouldn’t be afraid or get too euphoric when either happens.
Secondly, markets over time are upward trending, i.e. they rise in value over time, and that is the reason we invest in the first place.
Understanding these two simple truths will help you be calmer as well as know when to take advantage of market cycles. For example, we have a few clients who show up at our door whenever there is a ‘bloodbath’ in markets, wanting to invest to take advantage of the “sale”. It goes without saying that their portfolios tend to do better than that of the average investor. Do they know whether prices have hit bottom? No, but they understand that some discount is better than none, and they are content to patiently wait out the cycle to achieve their long-term financial goal.
Our role as advisers is to help you understand why you need to invest in the first place, match your goals and needs to the solutions, and help you focus on things that you can control – such as your savings rate and personal balance sheet – rather than the things you cannot, like the markets. Advisers also help you make sure that your portfolios are properly risk-calibrated, help in advanced planning needs such as managing generational wealth, and future-proof the assets you worked so hard to accumulate.
Last but not least, advisers should be reminding you to take advantage of sales in financial assets to help you reach your goals more quickly. That’s exactly what we’re doing now!
On that note, we at GYC would like to wish you and your loved ones a Blessed Christmas. May your holiday season be filled with peace, joy and love!
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