Why fear and greed are bad for investors - Priya Sunder In an ideal world, investors would always make money. They would buy low and sell high. Its a simple and logical statement, yet many investors find it hard to implement. Let us take a look at what motivates and drives investor behaviour, and what we can learn from it. Rewind to 2001. The Al-Qaeda attacked the twin towers of the World Trade Centre in New York. As terrified office goers made their way down the smoke-filled stairs to safety, they encountered a group of men in gas masks and fire uniforms climbing into the engulfing smoke and fire. They went up 93 floors to rescue people, knowing well that they wouldnt possibly survive the day. Of the 2,753 dead at the World Trade Centre, 343 were firefighters. What makes firefighters do this for a living? What makes them confront their worst fears and yet have the conviction to persevere? Another example of extreme conviction is from the 1990s, the height of the dotcom boom. Technology start-ups mushroomed at an incredible rate, and though many of them had no revenues or cash flows, they enjoyed billion dollar valuations. Future earnings were extrapolated on the basis of the number of views a site received. The investors who speculated in these companies grew rich overnight. In the midst of this frenzy, Warren Buffett declared he would not invest in businesses he did not understand. He was panned by other investors as outdated, but we know how that story ended. Fear and greed—both are extremely powerful emotions that drive the markets. Anyone who has been an investor over the past 10 years has been there. Greed drives us to buy more when the markets are helium-filled balloons, and fear pushes us to sell when the markets are like a limbo dance—how low can you go? The markets price to earnings (PE) ratio is a quick way to understand if the market is cheap or expensive. When you are looking at a single company, its PE ratio compares its share price with its earnings per share. Let us see how these investments fared. An investment of Rs 1 lakh in December 2007, when the PE was 26, became Rs 85,000 five years later, a loss of 15%. On the other hand, Rs 1 lakh invested in November 2008, when the PE was only 11, became Rs 2.28 lakh five years later, a profit of 128%. People clearly bought when they should have sold, and sold when they should have bought. This constant mistiming of the market and resultant losses are the main reasons many Indians keep away from from equity, viewing it as gambling rather than a reliable long term wealth creation engine. As a result, a dismal 3% of our population holds faith in the equity markets.
Posted on: Wed, 24 Dec 2014 11:55:17 +0000
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