Artigo internacional (em inglês): Our instincts ruin our investments

Posted on janeiro 28, 2010. Filed under: Comentários diários |

 

Beware of your instincts when investing in stocks â?? they are likely to cost you a lot of money. Start by reading this introduction to behavioural finance.

By Claus W. Silfverberg, former managing director of Danish Shareholders Association and director of World Federation of Investors Corporations.

 

Our basic human instincts made our predecessors survive on the African savannah, but our instincts are probably our worst enemy when it comes to investing in stocks.

 

Greed

 

Our greed instinct originally helped us to feed quickly and abundantly, whenever there was food available, but in the financial market it is far from rational to buy when everybody else are buying, and to fill our portfolio with just a few stocks. But this is exactly what happens. Stock markets and stock prices constantly overreact. When the market or a particular stock goes up, almost everybody is eager to get his or her part of the potential profit. The number of trades and the total turnover increase. Stocks and/or segments of stocks going up in price become popular â?? you feel good, and you feel safe, when you are doing like everybody else. But you are likely to be buying at a high price.

 

Vanity

 

You feel thrilled and you feel intelligent, when your investment yesterday already has proven itself profitable, and you hurry to buy some more of this wonderful stock. A positive stock market gives you a lot of positive strokes. Overconfidence is frequently seen, especially among male investors.

 

Actually one single profitable trade can convince a young male investor that he is a new Tarzan in the financial jungle. But most investors only end up with high trading costs and too few stocks in your portfolio.

 

Laziness    

 

On the African savannah our instincts did well to tell us to economize with our resources, but in the financial market it is highly dangerous not to do your homework. A huge majority of private investors, however, make their investment decisions based on intuitive judgements of small pieces of news, or they focus only on the short term evolution of a stock price.

 

Fear

 

Our instincts tell us to avoid and be fearful of something we donâ??t know.

 

 

 

So a large majority of the pension saving population â?? being newcomers to the financial market – completely avoid making investment decisions. All investment decisions are outsourced to a costly financial industry. Elementary financial literacy could significantly increase competition and reduce costs of pension saving management.

 

 

Stock investors reduce their fear in a number of ways:

 

1. Before investing, most of us feel certain that if a stock price or a stock market has gone up for a few months, days, or even hours, then it is likely that it will continue to go up. The same observation is valid for decreasing stock prices. We project the most recent past performance into the long term future. 

 

2. After having invested, most of us believe that our private purchasing price for a particular stock is the correct price for this stock, or we have great difficulty selling at a lower price and realizing a loss â?? and a personal failure. But if our stock price goes up, we immediately correct upwards our perception of the correct price.      

 

Finally it is also interesting to observe how private investors become more and more fearful as stock prices go down, and tend to reach panic levels just as stock prices bottom out.   

 

Conclusion

 

We like to think of ourselves as being rational investors, but in order to make rational decisions you need to have a long term financial objective, an overall portfolio strategy, and knowledge about the basic rules on how to invest in stocks. How are you doing in these fields?

 

Copenhagen, 24 January 2010 – Copyright: C.W.Silfverberg, cws@prisas.dk

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