Recently I had the pleasure of attending a presentation by Carl Richards. He is a financial planner from the United States and has a very unique and honest way of looking at financial planning and investor behaviour.
Carl discussed a concept he calls “The Behavioural Gap”. This is something most of us do when it comes to investing. We behave in contradiction to our usual behaviour. Usually when we see something go on sale, like food or our favourite clothing line, we tend to buy more of it. If you’re anything like me you scour advertisements for those luxuries and stock up when they’re at their cheapest price. Or you make a point of going to those Woolies winter sales and buying your kids clothing in one size up for the following winter season! When our favourite brands are at their most expensive, we avoid buying them and when they’re at their cheapest, we buy in bulk. Makes sense, doesn’t it?
However, for some reason when it comes to investing, we behave differently. We seem to buy shares when they are most expensive and sell when the share price drops – losing money in the process. It is as if we don’t trust our instincts and rather follow the herd. When the stock market (shares) is at its highest and the market is doing well, we all want more of it. What motivates this behaviour? Greed. Out of GREED we buy.
Recently when retail shares like Checkers, Mr Price and Woolworths were at their highest, everyone wanted to buy them; in spite of the fact that the intrinsic value of the company was well below the share price. Since the company is not worth the value it is being traded on the Johannesburg Stock Exchange, the share price can only go one way: down! But because everyone was buying these shares, including foreign investors, many of us followed suit. Currently the share prices of the mines are low, yet we avoid it. Maybe because of the bad publicity the mining sector is receiving or maybe because we follow what everyone else is doing. What motivates us to run in the opposite direction from commodities with low share prices? Fear. Out of FEAR we sell. Yet when we look at the history of the South African economy, we see the large part the mining industry plays and has played in our economy. Furthermore, if we do more research we see that many mines are very profitable and have large scale employee participation and empowerment schemes.
There is a gap in investor behaviour which is driven by fear and greed. A “Behavioural Gap” in which we lose money. We know the principles of, “buy low, sell high”, but our investor behaviour contradicts our common sense. We like the security of following the trend but often this is a poor strategy for investment. We may feel we have peace of mind but in the long run we damage our portfolio by investing in overinflated shares or selling shares too soon.
Next week we will continue investigating how fear and greed motivate our investment choices. For more information on Carl Richards and “The Behavioural Gap” please visit http://www.behaviorgap.com/about-carl-richards/