Emotions - your greatest enemy

Here is an interesting thought.
When the price of a good or service goes up, let’s say Banana’s or Petrol, our first inclination is to buy less. Right?
Then why do we not apply the same philosophy to financial assets? If the price of a listed share goes up, why are people more inclined to buy it......and looking at the reverse, if the price falls, they sell it. The same can be said for managed funds. Investors and Financial Planners are more inclined to purchase managed funds that have performed well over the past 12 months.
The problem is, people appear to incorrectly extrapolate past price changes into the future. This is unfortunate for so many reasons, not least the fact that there is overwhelming evidence to suggest that this behaviour destroys wealth. The Dalbar Study in the USA has found that over the 20 year period to 31 December 2009 the US Sharemarket S & P 500 Index had an annual return of 8.2% whereas the average stock fund investor averaged a paltry 3.2% (barely above the rate of inflation).
Investor behaviour is shaped by the false belief that there are market guru’s that can predict the future. This faith is placed in stock brokers, economists, managed fund analysts and Financial Planners. If the truth be known many investors are none the wiser as they do not have the ability to benchmark or “judge” their investment performance with their peers.
Poor asset allocation decisions and market timing nightmares also compound the problem.
Emotion is your greatest enemy. When people are most fearful, future expected returns are actually at their highest. Knowing this, why are people tempted to withdraw money from the share market at this time? Ultimately, investors will only succeed if they have the right plan and discipline in place.
Charles Kindleberger once wrote “There is nothing so disturbing to one’s well being and judgement as to see a friend get rich”. This is a very poignant statement, but should be a lesson to people that we need to constantly battle our emotions and biases and this sometimes needs the help from an expert.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances