Business | Opinion
Emotions, expectations and economics
One of the first things that an expatriate experiences when settling down in Dubai is the concept of "discounts" and "special offers" for many items throughout the year.
- By Harshendu Bindal, Special To Gulf News
- Published: 22:59 September 12, 2008
One of the first things that an expatriate experiences when settling down in Dubai is the concept of "discounts" and "special offers" for many items throughout the year.
Effectively, the ability to buy goods and services at discounted prices or the ability to buy additional goods and services for the same prices are tools used by the retail industry to increase sales.
The reasons may vary and whether it is the Shopping Festival or an "end of season" sale, the concept of a "bargain" seems to be well understood by the average consumer in Dubai and indeed across most of the world.
While most consumers have the ability to recognise a bargain when it comes to buying goods and services, the same cannot be said when they are buying (or speculating on) stocks or real estate.
The concept of "buy low, sell high" is simply forgotten when investing in the stock markets or buying other financial assets. Frankly, this is a global phenomenon and it is quite interesting to analyse and understand the reasons behind this.
Motivator
This may come as a surprise: For the majority of investors, fear rather than greed seems to be the greatest motivator.* Investors tend to be influenced more by the prospect of loss than by the opportunity for gain and only about 20 per cent of the population feels comfortable with higher levels of investment risk.
How does this affect investor behaviour? Invest-ors are often motivated to withdraw their money from investments based on fear or the influence of events publicised in the media.
Obviously, basing investment decisions on media news may not be the best method of managing one's finances.
Investors essentially try to "time the markets". Investors who want to time the markets are trying to essentially predict the future, which is impossible.
These investors think about missing the "worst" days in the markets, but also end up missing the "best" days which several studies have shown has a significant impact on the returns they eventually generate. People must recognise and overcome the fact that fear is driving their investment behaviour.
Blinded
When the market performs well, investors can become "blinded" by euphoria over their investment returns. They usually hope for bull markets and double-digit returns from their investments. The problem is this expectation tends to blur our memories of bear, or declining stock markets.
The reverse happens when stock markets are not performing well. Memories of bull markets are forgotten and fear prevails all around. Now let's look at three investor types and their expectations of the markets.
The Optimist tends to think the stock market continually rises, but fails to consider the many short-term fluctuations that have occurred throughout history.
Encouraged by high returns, some optimists invest additional money in stocks which may be borrowed; however, their risk tolerance might not match their appetites for performance.
In fact, the optimist's portfolio may be so overexposed to stocks that he or she has overlooked bonds or other fixed income opportunities, which could add valuable diversification to a portfolio.
When expectations are unrealistic, optimists set themselves up for disappointment and make panic decisions when the market doesn't go their way.
In contrast, no matter how strong the stock market may be, naysayers are always around.
The Sceptic tends to see the stock market as relatively flat or going sideways. In his mind the market always has ups and downs, but remains even overall. These investors lose sight of long-term growth opportunities in stocks.
Yet even when you include the effects of the worst bear markets, stocks have historically provided solid, long-term returns on average. Since sceptics believe the market will stay relatively flat, they either don't invest or under-invest in stocks and miss significant growth opportunities.
For some people, the fear of incurring a loss is their overwhelming decision-making factor. Rather than deal with any degree of loss, Pessimists choose to invest in ways they believe are risk-free. They tend to see the stock market as something that will likely go down.
Inappropriate expectations could set up a pessimist for missed opportunities. Not only can pessimists lose purchasing power over time, they can miss out on the relatively higher performance potential growth stocks have historically offered.
Cycles
As you study the performance of the stock markets over longer periods of time, you'll find that they always go through cycles. There are periodic bull and bear markets but the long term performance is generally positive.
Also, the higher the risk or volatility of a particular asset class, the higher the performance over the longer term. All investors who forget about the cyclical nature of stock markets are likely to suffer in terms of performance.
On the other hand those investors, who invest in stocks after understanding their risk appetite and have the patience to ride out the different cycles, tend to perform well over a period of time.
The current regional situation suggests that stock markets are in the correction mode and we have recently seen reports that suggest a correction is round the corner in the real estate markets as well.
The normal reaction for an average investor would be to show a lack of interest in buying regional stocks and to panic and start selling their real estate investments.
The alternative and I guess the big challenge for all of us is to keep our emotions in check; temper our expectations to avoid disappointments and let the long term economic reality of the markets work in our favour. My guess is that this is easier said than done.
*Source: The Third Annual Congress on the Psychology of Investing, June 1997 (Boston, MA). Kathleen Gurney, Ph.D., Financial Psychology Corporation.
The writer is a senior director at Franklin Templeton Investments. The views expressed in the article are his personal opinion.
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