Fear Of Loss Can Lead To Portfolio Under Performance
The markets may act nasty at times which spooks investors for sure. In such nasty times fear creeps in slowly and panic created leads to most investors taking wrong actions. Can we blame this fear on human psychology? If we were to ask someone, which is the biggest fear he/she has when it comes to investing money in the market, the answer is: “It is the fear of losing money”.
No one clearly wants to lose even a penny. Studies over the years have suggested that the pain of losing is twice as strong as the joy of winning. It aches more to lose Rs.100 when compared to the happiness of winning the same Rs.100. There are ample reasons that create this illusion of fear in the minds of an investor when the markets do not behave as expected.
Humans are a complicated bunch, but everyone is unique in nature. Similarly, one person’s stimulus to fear would be different from the other. Fear is a personal experience and how we react to it thus depends on our previous experience. As humans, it is not just the experience we have had in the past, but also it could be an experience faced by a friend, a family member or even some story we have read. These are the influences that trigger our fear.
When an investor encounters a sudden correction in the market, the first instinct is to freeze and to wait. During this interval, the brain preps the person to take further action, which is to fight or take flight—either of the two moves decides the fate of the investor's equity portfolio. The end results of fight or flight are drastically different. Fight would help the investors to build requisite defenses, whereas flight would influence them to pack their bags and exit the situation (at a loss or minimum gain). Most of the investors would succumb to fear and lose out on the opportunities that fear prevents them from grabbing. Investors act melodramatic and lock in minor gains to avoid losses.
However, this behaviour could lead to trouble. The secret is not to panic and not to take impulsive decisions when the market scares you. It is very natural to be scared, but we have to remember that the comeback is in our hands. A cool and composed temperament would put you right back into the driver’s seat, no matter where the markets are taking you
Several kinds of fear of investors
Fear of losing money is a common fear of all, be it rich or poor. In fact, the more you have, the more you could lose and, therefore, greater the potential of fear in any given individual. Fear could be triggered by negative news or rumours because any news that attacks our economic well-being is likely to trigger this emotion. The more grave the situation, the more pronounced the urge for panic selling. Humans have a tendency to follow the herd, this simply means that sometimes investors in panic mode would do what everyone else is doing without taking into consideration the cause of the situation. This is a negative move on the part of investors.
Fear breeds more fear, it is extremely difficult to stay calm in a situation and think rationally when people around you are panicking. Your mind would trick you into believing that everything at this point is a disaster. A story or a rumour seems more believable when more people around us are claiming it to be true. When this situation arises in the market, you find yourself amongst those who are selling as a response to a bad news. This is because you start believing that it is rational to do what others are doing because at this instance your brain has convinced you that this is a realistic situation and it is unwise to tell yourself otherwise and act calmly. In a similar situation, you might hear negative news, but if you do not see people reacting to it in huge numbers, you would simply be indifferent to it.
Individuals retain all their past fears of the market once they have had a bad experience. You will always fear the recurrence of the unfavourable situation, whether consciously or subconsciously, or both. If you had made an investment in the past which led to massive losses, the next time you invest money in the market, you would naturally be nervous and have the fear of losing it all again and be afraid of having to go through the heart wrenching pain of losing the money. Humans are conditioned in a way to take cues from similar situations and take precaution for fear of going through the same trouble again. In short, we want to avoid the pain of losing.
How we as investors react to any news has a huge effect on the market situation. An investor faces a constant attack of emotional stimuli in the market. News, gossip and sharp market corrections can set the nerves trembling. Once you lose your mental balance even for an instance in the given situation, your will and reasoning will break up with you and you will land up doing what the vast majority of the market participants are doing out of impulse.
Another major trait found in investors is the fear of missing out, which can be attributed to the greed of an investor to just be a part of the rising trend, but not acting on a desire to own a stock This is a major mistake made by naïve investors where they buy the stock based on rumours and hype and take positions when the uptrend is mature and nearing its end. With lack of self-study and understanding, investors are putting themselves in a losing position.
From the above table, it is evident that within just 6 months, 94 per cent of the stocks recovered from the ‘scary’ fall witnessed on July 6, 2009. What we are trying to say is that, have patience, keep a long term horizon and do not fear the markets when it is going through turmoil and do not react to it in a knee-jerk fashion. Some stocks do not move with the market trend. Timing is very important when it comes to markets. One should take decisions after proper study of the company background and quarterly earnings, while also keeping in mind the industry performance. It is unfortunate as some stocks never recover, in such cases it is smart to sell at a minimum loss and invest that money in another stock which is fundamentally stronger. Investors who took the opportunity of the market correction must have been the happiest investors 6 months down the line.
NEWS: Monday, July 6, 2009 (Source: Ace Equity) The Indian equities markets saw a huge sell-off on Monday, with the Sensex witnessing its fourth biggest fall ever, as the Union Budget presented by finance minister Pranab Mukherjee failed to win over investors. Sentiments turned negative after the FM said that the fiscal deficit may rise to 6.8% of GDP in the year ending March 31. The budget probably failed to give assurance as to how the government will go about the fiscal consolidation process, after increasing the fiscal deficit target. Marketmen sensed that the budget was not laden with sops and hardly had anything on disinvestment, banking and finance sector reforms. By the time the budget speech was concluded, benchmarks had already plummeted more than 4%. Broader indices equally suffered, causing a notable damage to the market breadth in the end. The global cues, too, were not very supportive as most Asian markets ended lower on concerns over the recovery of global economy. Banking, realty, capital goods and metal sectors were the worst hit. Big names like Reliance Infra, ICICI Bank seemed helpless, shedding nearly 10-12%. Fast moving consumer goods counter was the one to have escaped the trauma, but the performance was not very imposing. Finally, the 30-share BSE Sensex lost 869.65 points or 5.83% to end at 14,043.40 and the S&P CNX Nifty declined 258.55 points or 5.84% to settle 4165.70. The market breadth on the BSE remained in favour of losers; there were 1761 losers, as against 690 gainers, while 76 remained unchanged.
An investor’s heart must be racing after reading the news item given above. On July 6, 2009, the Indian markets suffered one of the biggest intra-day falls until now and it was a nail-biting period for the investors. The reason for the fall could be attributed to the investors being unhappy with the Union budget presented by the then finance minister. The response of the investors to the budget news led to heavy selling, which resulted in the markets falling drastically on an intra-day basis. There were investors who took advantage of the situation and sold their stocks and must have also made some good profits, but definitely there would have been investors who blindly followed the market movement without calculating the risks associated with selling at that point. What we as investors forget during times of panic is that ‘my situation is very different from his situation’. Maybe during correction, some investors are selling at a profit, while some are selling at a loss. Selling under peer pressure is a miscomprehension on the part of investors. Let us take a look at the table (on next page) which showcases the Sensex Constituents on July 9, 2009 when the BSE Sensex had fallen by over 5 per cent. Also, take a look at the Sensex constituents and their returns post one of the biggest intra-day falls.
The secret is not to panic and not to take impulsive decisions when the market scares you. It is very natural to be scared, but we have to remember that the comeback is in our hands.
Investors should take advantage of a downtrend or a market crash as this offers them attractive valuations and an opportunity to invest their savings at a good price. Be alert and be aware and think for yourself.
Healthy Investment Practices To Manage Fear
1. Determine which investment strategy works for you : Every individual has his/her own set of plans and demands. Select the right strategy, one that fits your needs. No one knows you or your situation better than you do. Identify your investment traits and manage them accordingly.
2. Find your accurate investing path : Market advisors and experts will always tell you to diversify your portfolio. Do not put all your eggs in one basket. This way even if a couple of stocks pull the value of your portfolio down, there will be others that would cushion your portfolio.
3.In bad times, acknowledge the fear: To act calm in fearful times, the first thing to do is to accept the situation and the fear that you may be in a position that you did not want to be in, but you have to have a rational plan of action from there. To be rational and objective you have to understand the situation and take correct action
4. Calm temperament: “The most important quality for an investor is temperament, not intellect,” -- Warren Buffett.
To be a great investor, you need the right temperament which is of utmost importance. It is not mere knowledge or intelligence. Temperament is the way a person behaves or the types of emotions the person tends to exhibit. If a person is calm and collected and does not panic, s/he is an example of a person with a calm temperament. With a calm and composed temperament, one can take wise decisions which may be different from what the crowd is doing.
5.Learn from past mistakes : The market is extremely hard to predict. It will be volatile. To be a great investor, one has to have an intimate relationship with the market. With time, one will gradually grow, and to grow, one has to learn from the mistakes made by others or oneself in the past. Successful investing is a bitter-sweet journey.
6. Keep a balance between greed and fear : An investor should not be greedy and neither should be fearful. Avoid getting swept up by the temporary turmoil. Out of greed, an investor may find himself at a loss, and the same could happen even out of fear. It is a balancing act between greed and fear that one must master.
7. Money Management : When you find yourself making a gain in a bull run, take a portion of it and maybe invest the money in relatively safer investment options so that you do not lose your calm at any time.
8. Long-term approach because patience is the key : Long-term investors embrace the inevitable short-term volatility of the stock market. All markets are prone to uncertainty and volatility. Without volatility, you cannot make gains. Have good faith and be optimistic and stick to the long-term approach. Remember that nothing is constant. What goes up must come down and also what goes down bounces back. It is about the timing and finding the right opportunities. Do not rush into any decisions and always look out for lurking opportunities and be patient.
9. Know your friend from foe : The only person to gain or lose in a market is the investor himself. News, rumours and stories could at times be your foe and lead to your downfall. Believe in your study of the market condition and the company, have faith in the company you are invested in, check if the company officials have made any comment rather than believing the news which is not complimenting your strategy, keep a track of the reasons why you had invested in the particular stock and analyse them to check for differences as time passes. As Peter Lynch advises: “Know what you own, and know why you own it.” Independent thinking and confidence in your actions are necessary keys to sustaining glory.
10. Analyse the worst case scenario:
“Unless you can watch your stock holding decline by 50% without becoming panic stricken, you should not be in the stock market,”
-- Warren Buffett.
Before you step into the market or before you make an investment in a company, always consider the worst possibility or the worst case scenario that you as an investor can handle. Plan what you should do if unfortunately you find yourself in the worst case possible. When you are psychologically prepared for such an unfavourabe situation, you can pull yourself out of it. This way you would avoid the feeling of panic and fear since you must have already planned an exit strategy in the very beginning.
11. Rid yourself from gut feeling: “The trick is not to learn to trust your gut feelings, but rather to discipline yourself to ignore them. Stand by your stocks as long as the fundamental story of the company hasn’t changed,” -- Peter Lynch.
Investors feel anxious and uneasy when everyone around them is scaring them and trying really hard to tell them that the worse situation is very real. At this point, your gut will tell you the same and it may lead you to believe and do things which you would not have done if you were not put under pressure. Thus, ignore your gut feeling in times of turmoil and use your judgement and study of the company and the situation to deal with the situation.
Conclusion
Markets are uncertain and there will be times when an investor would be in terrible situation and be fearful of the outcomes. But fear should not keep you from investing money in the stock market because your money will not even have the chance to grow in the form of cash. It is rather riskier to keep cash as your wealth will not grow faster than the prevailing rate of inflation, which results in lower spending power. Invest in the stock market! Stock market is one of the best ways to construct your wealth over time. Markets are definitely volatile and the downtrend is terrifying. Banish the fear from your mind and be as objective and unprejudiced as possible in uncertain times. Investors should take advantage of a downtrend or a market crash as this offers them attractive valuations and an opportunity to invest their savings at a good price. Be alert and be aware and think for yourself.
Prices in the market are empirically determined by the attitude of the investors towards emerging economic and financial environment, rather than the environment itself. Price fluctuations are factors of market participants’ hopes, expectations and actions, biases and fears. The markets themselves are driven by crowd emotions. Nothing you can do will change that, it is a fact we all have to accept. Your job as an investor is to try and ignore those around you and form an independent opinion while making a genuine attempt to overcome your own prejudices. Overcome your mental weaknesses, fight your fear and stay rational. Rise above the crowd to emerge a winner.
We definitely agree that losing a large portion of your equity portfolio's worth is difficult to digest, but the truth is that rebuilding the portfolio anew would be much more difficult task during a market downturn. So, it is better to remain invested during such times.
Remember that you hold the key to your portfolio’s health. Stick to sound investment decisions and keep in control your emotions. Avoid blindly following the market sentiment and always stick to your long-term portfolio strategy. It is all about maintaining the balance that would require you to keep your wits in place.