Heights always scare us. Suppose one is riding a giant wheel he fears most when at the top and mostly not when one is down. However, when it comes to investing in equity, people adopt a different attitude. For example, most people are confident of investing in stocks when the sensex is at 21,000 compared to when it was at 14,000 level.
Legendary investor Benjamin Graham in his book The Intelligent Investor writes that the intelligent investor realizes that stocks become more risky, not less, as their prices rise and less risky, not more, as their prices fall. The intelligent investor dreads a bull market since it makes stocks more costly to buy. And conversely and so long as you keep enough cash on hand to meet your spending needs, you should welcome a bear market, since it puts stocks back on sale.
We all know what is stated above is true. But if we behave otherwise feel bullish when markets rise and feel bearish when markets fall then we should place ourselves in the category of “Less intelligent investor.”
In real life, most of us feel confident to invest at 21,000 and fear equity markets at 14,000.
Most important reason for the above mentioned behavior is the anchoring effect. We tend to link our decision to previously demonstrated number. Suppose the market has moved from 8,000 to 21,000 to 14,000. Firstly, at 21,000 levels, we will have 8,000 levels in mind and hence we will feel euphoric. At 14,000 levels, we would have 21,000 levels in mind and hence will feel dejected. At 14,000 levels we tend to forget about 8,000 levels.
Having anchoring effect is like driving the car only by watching the rear view mirror. If we keep driving the car by only what is in the rear view, we can only see that has gone to bang the car somewhere. To move ahead, we must look what is ahead. Rear view mirror only acts as guiding post.
Further in life it is always prudent to buy required goods and services at the least possible cost. When equity markets fall, it gives us opportunity to buy stocks at lower prices. However, we sell our stocks when the prices are falling (low) and we feel safe the prices are rising.
Investing is a strange business. It’s the only one we know of where the more expensive the products get, the more customers want to buy them.
Since most investors buy a higher levels and sell at lower levels. The intelligent will have to behave contrary to the head. It takes patience, discipline and courage to follow the contrarian route to investment success: to buy when others are despondently selling, to sell when others are avidly buying. Individuals who cannot master their emotions are ill suited to profit from the investment process.
Some investors will reveal that like some of the more inexplicable movies, some investments appear to have no plot or plan. If the movie is really clever, towards the end it slowly dawns on audience that the bits and pieces are falling together, giving a clear picture and often leading to a stunning climax. Sadly, no spellbinding end awaits unplanned investments, or at least not one that makes an investor comfortable. More often than not, investor is left feeling repent, perhaps with a mild heart burn thrown in, and always the promise to make up for a past mistake.
Another strategy is to watch the asset allocation at all times. It is quite common to see investors allowing their portfolios to ride a bull market – the original balance of equity and debt goes flying out of the window in the quest to maximize returns. But equity requires a long term commitment, and it is equally important to maintain the proper asset allocation. In other words, re-balancing one’s portfolio, either up or down, is necessary for long term success. Portfolio rebalancing is the process of bringing the different asset classes back in proportion, following a significant move in one or more asset classes.