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Categories:Investments,Other

Emotional response

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I am finding it difficult to reconcile the upbeat tone I am hearing from investment managers with the dull performance of markets.

This is not meant to be an about face following last week’s article. Rather, it is an acknowledgment that emotion still plays a considerable part
in investment thinking.

Perhaps it should not, particularly for someone such as me who has been steeped in this industry for nearly half a century - but it does.

The influence that irrational emotion might have on shares was brought home to me through an article written by a colleague for publication in a newsletter I edit.

This newsletter has yet to be published, so far be it for me to disclose the full extent of his findings but I cannot ignore some of his conclusions.
Some, indeed, are embedded in investment folklore.

“Don’t marry your stocks” is a well used adage. But investors do. Unfortunately, it is usually because these are the shares that have failed to live up to expectations.

This is where emotion takes over and rational thinking goes out of the window. The tendency is for investors to take profits in their most successful shares and run the losers. In other words, they are ditching the winners and sticking with those that have disappointed.

My colleague used an US gameshow as an example of emotional rather than rational thinking.

Played for maximum effect, participants were given the choice of three doors behind only one of which was a star prize. When the first player
failed to pick the right door (and they always did), the remaining contestants were given the chance to stick with their choice or change. They
almost invariably stuck. Yet logic dictates that the odds had improved from one in three to one in two. At the very least, you needed to reconsider - not that many did.

Apparently, the odds favoured those who switched. Quite why does not seem immediately apparent but transpose this scenario into that of an
investor reassessing his or her choices and you can start to understand why emotion can distort the decisiontaking process.

The problem is that by switching horses - whether from a poorly-performing share into yet another unknown or from one door to another in a gameshow - you are admitting that an earlier decision was wrong. And we really do not wish to admit we were wrong, do we?

The consequences are a trail of failed competitors in a gameshow and a portfolio more likely to resemble last year’s has-beens than next year’s likely winners.

Nothing, of course, is ever that simple. Still, it did encourage me to adopt the all too simple approach oflooking at my investment portfolio as if nothing is sacred and anything could be changed. Easier to say than to implement, I feel, but a discipline worth adopting if you are not going to end up with a retro-portfolio.

And with the pace of change as rapid as it is, looking each week is probably no bad thing.

My sense of uncertainty was not particularly helped by last week’s closed-end funds webcast - worth a look on the Brighttalk website. Chairing
a discussion between senior representatives from Witan, Martin Currie, Cayenne Asset Management and Morningstar, I found the realistic
appraisal of the economic situation - a slowing Chinese economy, Eurozone sovereign debt problems, rising inflation - at odds with the fact that these global growth managers were borrowing to invest.

They were, of course, taking a longer-term, measured view - rational, not emotional - based on valuation criteria and a solid belief that we would somehow emerge from the current slough of economic uncertainty.

Leaving my more emotional investing approach to one side, I suspect they are right. It does not make me feel more comfortable just now, though.

Brian Tora is an associate with investment managers JM Finn & Co

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