What does it mean to be brave?

This means that to understand bravery, we need to understand fear.

This next section was written by Adam Hayes in an article entitled: Financial Markets: When Fear and Greed Take Over and which article perfectly illustrates these concepts. Given current heightened market volatility I have, however, edited it to focus mostly on fear.

There is an old saying on Wall Street that the market is driven by just two emotions: fear and greed. Although this is an oversimplification, it can often ring true. Succumbing to these emotions, however, can also profoundly harm investor portfolios, the stock market's stability, and even the economy on the whole. There is a vast academic literature, known as behavioural finance, which is devoted to the topic of understanding market psychology.

The Influence of Fear

Just as the market can become overwhelmed with greed, it can also succumb to fear. When stocks suffer large losses for a sustained period, investors can collectively become fearful of further losses, so they start to sell. This, of course, has the self-fulfilling effect of ensuring that prices fall further. Economists have a name for what happens when investors buy or sell just because everyone else is doing it: herd behaviour.

Just as greed dominates the market during a boom, fear prevails following its bust. To stem losses, investors quickly sell stocks and buy safer assets, like money-market securities, stable-value funds, and principal-protected funds—all low-risk but low-return securities.

Following the Herd vs. Investing Based on Fundamentals

This mass exodus from stocks shows a complete disregard for long-term investing based on fundamentals. Granted, losing a large portion of your equity portfolio is a tough pill to swallow, but you only compound the damage by missing out on the inevitable recovery. In the long run, low-risk investments saddle investors an opportunity cost of forfeited earnings and compounded growth that eventually dwarf the losses incurred in the market downturn.

Just as scrapping your investment plan for the latest get-rich-quick fad can tear a large hole in your portfolio, so too can fleeing the market along with the rest of the herd, which usually exits the market at exactly the wrong time. When the herd is fleeing, you should be buying, unless you're already fully invested. In that case, just hold on tight.

The Importance of Comfort Level

All this talk of fear and greed relates to the volatility inherent in the stock market. When investors find themselves outside of their comfort zones due to losses or market instability, they become vulnerable to these emotions, often resulting in very costly mistakes.

Avoid getting swept up in the dominant market sentiment of the day, which can be driven by irrational fear or greed, and stick to the fundamentals. Choose a suitable asset allocation. If you are extremely risk-averse, you are likely to be more susceptible to fear, therefore your exposure to equities should be smaller than that of people with a high tolerance for risk.

Buffett once said: "Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market."

This isn't as easy as it sounds. There's a fine line between controlling your emotions and being just plain stubborn. Remember also to re-evaluate your strategy from time to time. Be flexible—to a point—and remain rational when making decisions to change your plan of action.

Key-takeaways

• Letting emotions govern investment behaviour often leads to irrational decision-making that can cost you dearly.
• It's usually best to ignore the trend at the moment—whether bullish or bearish—and stick to a long-term plan based on sound fundamentals.
• It's also critical to understand how risk-sensitive you are and to set your asset allocations accordingly when fear and greed grip the market.

Image reference: Behaviour Gap

The Bottom Line

Sticking to sound investment decisions while controlling your emotions—whether they be greed-based or fear-based—and not blindly following market sentiment is crucial to successful investing and maintaining your long-term strategy.

Recognising that this is hard to do on your own you may want to turn to your ‘Coach’ who will not allow volatile market forces to interfere with your peace of mind and who can offer suitable alternatives to avoid or minimize losses at all costs. Read article here.

Be brave!

Is ‘Do-it-yourself’ investing (via an Unmanaged Personal Share Portfolio (PSP)) a good idea?

In an excellent recent blog post by Ted Lamade entitled ‘The Rise After the Fall’ (see: The Rise After the Fall · Collaborative Fund) he writes that the last decade and a half has been a period characterized by low-interest rates, abundant capital, unlimited support from both the Federal Reserve and the U.S. government, and low commodity prices, nearly every investable asset has appreciated in value. He then poses the question, if the resultant effect of these tailwinds has been the creation of a generation or two (or even three) of investors with an elevated opinion of their abilities?

While there are certainly some pros to DIY investing, it lacks some of the advantages of receiving professional advice and advisory services. Importantly good portfolio management isn't just about posting profits when the market's up, but curbing losses when it's down. That can be hard for an amateur to accomplish.

Has your DIY investing been exposed recently?

If you are a DIY investor and you would like to consider a professional money manager then chat to your PSG Wealth Adviser.