Behavioural economics gives us excellent insights to leverage our instincts and intellect for investing. Let’s consider three emotional situations of Stress, Panic, and Greed.
Stress: Lets say Sachin Tendulkar is coming to bat when he has failed to get runs in the last few games. It is only natural that he is thinking about his last few failures. You can visibly see that he is checking his shots and he hardly looks like the maestro that he is. Even a lay man can tell that he is over thinking his game. Let’s say he hangs on and scratches around till he gets to a 50 and then you see a much different Sachin who is playing with the flow, he does not check his shots anymore and the runs also start to flow.
A lifetime of practice has honed Sachin’s instincts which tell him exactly how to play the ball once he see it. He will not be able analyse the ball and choose the correct shot in the milliseconds he has to execute, he just has to follow his instincts.
Leveraging this insight for investing: In times of stress when one is performing an activity where there is considerable expertise then one should try and listen to ones instincts. If one is a seasoned investor then one should trust ones instincts in the time of stress.
Panic: Let’s say one encounters a situation like an earthquake instinct tells one to run, but one may be better off getting under a table. Similarly when one is accosted by a robber, instinct may tell one to fight or run, but one may be better off handing over the wallet.
When one encounters a situation which is a surge of negative emotions one should take a step back to listen to ones intellect as our instinct is ill equipped to handle this.
Leveraging this insight for investing: Market crashes or steep falls in ones favourite stocks are times of panic for many investors. Market crashes have always seen many investors move away from the markets but this may be a good time to check our emotions and look for excellent bargains. Crashes in ones favourite stocks can tempt one to buy more to average the cost of ownership, this is the time to step back and analyse causes of the crash and calmly evaluate investment decisions.
Greed: It’s not uncommon to hear about a friend or a relative who has been conned out of a lot of money by an offer of extra ordinary returns like paying money to collect a lotto one has won in some far off country or “lending” money to someone who has a lot of wealth tied up in some other country and who is willing to return the money lent many times over.
Instinctively we are “programmed” to seek pleasure, which is the reason why we get excited when we see photographs of interesting food or beautiful people. Conmen understand this and appeal to our “pleasure seeking instincts” and hope that we don’t use our intellect in this excited state.
Leveraging this insight for investing: People invest in bubbles because someone is telling them that “this time it is different” and the pleasure seeking instincts want one to believe this. When one encounters a “once in a life time” or “this time it is different” offer, it is the time to use ones intellect. Objective analysis in these situations will keep one in good stead.
All of this is easier said than done, but understanding when to use our instincts and intellect will improve our chances of being better investors.