All our instincts tell us that it’s easier to stay with the herd than to turn and run the other way. But in investing, Martin Hawes says you should do exactly the opposite.
“Buy in gloom, sell in boom” – I live and breathe by this old investment saying.
Effectively, it’s a call for counter-cyclical trading, which is doing the opposite of what everyone else is doing. If this strategy was followed properly, investors would sell when markets were high, and buy when they were low. What could be easier and more sensible than that?
Well, buying in gloom and selling in boom is sensible and it does sound easy – but not many investors do it. In fact, most people buy when markets are high and sell when they are low – the very opposite of what we’re supposed to do.
It’s hard to be rational
The answer is, of course, that when it comes to investment, we’re not always rational. Investment markets are not driven by calm, rational analysis – they are driven by emotion.
Specifically, two emotions come into play for investors – greed and fear.
Greed is the emotion we experience most often when markets are booming. We see all the stories in the media about other people making their fortunes, so we worry that we’re missing out. After we procrastinate for a bit, greed gets the better of us and we buy in – often at the very top of the market.
A similar scenario plays out when markets tank. Again, the media amplifies the noise – when markets fall, news reports would make you think the world was about to end. Investors try to hold on, but eventually the fear of complete collapse and being wiped out financially means that we give up and sell.
A ‘market’ is really just a collection of people: buyers and sellers, who each have their own thoughts and feelings. You can’t assume that they all behave rationally, because they don’t!
In fact, like our ancestors when they roamed the savannah millions of years ago, investors herd together, seeking the safety of the crowd.
Markets behave like reef fish. They dart hither and thither, keeping close together in their large shoals, and respond out of all proportion to the slightest bit of news – both good and bad. This behaviour is driven by emotion and often makes some market participants look like they’re crazy.
Look at Warren Buffett
In fact, those who are excessively driven by emotion are the easy-beats of the markets. Investors like Warren Buffett take advantage of this, although this strategy does take courage and high conviction.
Take Bank of America. In 2011, the bank was in legal turmoil following the sub-prime crisis. It was facing economic concerns, uncertainty about government regulations, legal liabilities, and perhaps insufficient capital to pay back investors.
This meant most of the market was herded together, shaky in its fear. Many expected the bank to fail; nearly everyone was selling their shares.
Just when all seemed lost, Buffett calmly stepped up and invested US$5 billion in preferred shares in Bank of America. That sounds easy with hindsight, now we know that the bank survived and its share price is healthy. But it wasn’t easy then – Buffett was swimming against a rip tide. While everyone else was fearful, Buffett was greedy.
That gutsy deal, done at such a dark, gloomy time, has provided Buffett with a profit of over US$13 billion.
Look for the silver lining
Investors like Buffett do not fear events like the global financial crisis: they welcome them as big opportunities to pick up great assets at bargain-basement prices. As investors, they’re calm and rational – and they don’t let emotions and instincts cloud their judgment or drive their behaviour.
This thinking is behind much of the relatively new discipline of ‘behavioural economics’. This science recognises that we are not always rational, and that the choices we make are often not in our best interests, but are affected by our biases and emotions, and influenced by our friends and society.
Most people don’t make investment decisions by calmly weighing the costs and benefits – only a few have the self-control for that.
Instead, we use heuristics (rules of thumb) that allow us to make quick decisions even though they expose our prejudices, feelings, and social influences.
The best investors don’t get caught up in the noise of the markets, but are able to remain ‘contrarian’, going against popular opinion.
They stand against the tide, buying when others are fearful and selling when others are greedy. In the words of Baron Rothschild, they buy when there’s blood in the streets. That’s when the best bargains are found.
By Martin Hawes
First published 1 February 2018
Martin Hawes is the Chair of the Summer KiwiSaver Investment Committee. The Summer KiwiSaver Scheme is managed by Forsyth Barr Investment Management Ltd. You can obtain the Scheme’s product disclosure statement and further information about the Scheme on our website at www.summer.co.nz. Martin is an Authorised Financial Adviser and a Disclosure Statement is available from Martin Hawes on request and free of charge.
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