Investor_Psychology-rec01-mixdown

The podcast discusses emotional factors that affect investment decisions. The first factor is greed and fear, which can lead to irrational investments. Greed can cause investors to take excessive risks, while fear can make them sell prematurely or avoid investments altogether. The second factor is regret aversion, where people avoid making decisions out of fear of regret. This can lead to missed investment opportunities and suboptimal portfolio performance. The hosts emphasize the importance of focusing on the long-term and establishing a disciplined investment plan to mitigate these emotions. They also discuss the need to accept some level of risk and not overreact to market fluctuations. Okay. I think you're good to start. Give me one second. Welcome to today's show, everyone. Today we are discussing emotional factors which affect investment decisions. How are you doing today, Ishmael? Good. Bryce, how are you? I'm amazing. These are amazing times with the market. And with confusion with the markets, everyday investors sometimes have emotional feelings when it comes to their investments. And I think this is very prudent over the long term, being able to identify what's an emotional behavior and what is affecting your investment decisions. Absolutely. I would honestly argue that the emotional side, the behavioral finance side of things are just as important as the actual plan or the investments themselves. Because you can have a great plan or a great investment in place, but if you don't have the right mindset and you're going to run into these emotional factors that we're going to discuss, it can really throw everything else off of the track. And we'll wrap into the behavioral finance part, which Ishmael just alluded to in our next podcast. But strictly for this one, we'll deal with emotional factors, which would be playing a significant role in shaping you as the investor's behavior. And just being aware of these emotions, aware of these emotions, how you as an investor would like to affect your decision making process. Absolutely. So the first emotional factor we're going to talk about is greed and fear. Greed and fear, they're powerful emotions that can lead to irrational investments. So greed can push investors at excessive risk, while fear can cause them to self prematurely sell or avoid investments altogether. Have you had any clients, have you had any clients epitomize these emotions? Should I say the client thing or no? I almost feel like I should leave out pointing out specific clients. Are there any examples? Should I say it that way then? Just maybe what are your thoughts on these two things, Ishmael? What are your thoughts, Ishmael, on this first emotional factor? Yeah, greed and fear, I'm glad those are the first two that we're talking about because they're some of the most critical ones. If you're investing, say for a house, you… if you're investing for a house, some folks might tend to try to take on more risk and the only reason they're taking on more risk is they're trying to get that higher return right. They're trying to… and it's greed. They're wanting to just get, what if I just get a little bit more, I'll feel so much better on my investments. And then on the complete opposite side of that, the fear thing is, hey I've worked really hard for this. I don't want my balance to go down like it did in 2008. What can you do to eliminate this? What can you do so that this just isn't possible? And the markets are just volatile. They're going to move up and down but as we look at it Bryce, you and I are huge fans of just looking at the long term game and not the short term game. In the short term game, investing is like a weighing machine but in the… sorry in the short term, investing is a voting machine. In the long term, it's a weighing machine. So in the short term, it's going to be up and down. It's going to be really volatile but over time, we're going to see that consistency if you're able to write it out, you know, these greed and fear emotions that come from the market. Absolutely and most of these emotional factors are always in my mind short term related, right? You are looking at investors that want to take excessive risk which usually means they're trying to tighten the market, they're trying to make bigger bang for their buck and try to use all the water out of the rock on some specific investment in the short term. And fear is usually relative in the short term to someone avoiding whatever calamity and void there is out in the market and missing out on any opportunity to invest their money. Bryce, I do think we should mute the mics because they're catching feedback, I think. Okay, okay. One thing Bryce is… we… one thing Bryce is… gosh dang it, how should I wear this? One thing Bryce is, when do we see greed and fear? And we have a quote that you and I are huge fans of that we always talk about from Mr. Uncle Warren Buffett who he says, be fearful when others are greedy and be greedy when others are fearful. And I love that quote because in times when the market is through the roof, you know it really hurts especially new investors that don't know anything because they're seeing everybody else make money, this thing is just going up, it's in the greens, let me jump in because my neighbor or my brother or my sister-in-law, whoever made money in the stock market so let me just jump on in. Well this can be really detrimental especially to the other emotional factors when the markets go down because they bought in at such a high price without looking at the fundamentals of where things were, what's overly priced, what's underpriced and then the market just takes a nosedive. But then it's the opposite for some folks where when the market is going down, they want to sell early, they don't want to buy and you and I are always referencing to that water bottle example. If we go to the store right now and we see a bottle of water for $1 and we buy it tomorrow, if we go and they're for $0.25 or $0.50 a piece, we're going to buy more right? They're on sale, it's at a bargain and that's what we're looking to do with our investments. It's hey, where are the undervalued opportunities rather than the overvalued opportunities and not being greedy and not being fearful when others are fearful but doing the opposite, being fearful when others are greedy and being greedy when others are fearful. Absolutely and the mitigation strategy that you would employ in this case to eliminate the greed and the fear in the market would be to establish and stick to a disciplined investment plan over the long term which is going to mitigate a lot of the emotional biases you will have with the markets going all the way up like Ishmael alluded to or missing out on an investment opportunity because you think the crash is coming or you think the market's going to adjust. All right, then the second emotional factor would be regret aversion. So a regret aversion, that would be a tendency to avoid making decisions out of fear of feeling regret later. So this can lead as well as the first emotional factor to missed investment opportunities, to missed investment opportunities as well as suboptimal portfolio performance. So could you speak to more… could you speak more on that Ishmael? Yes, absolutely. One thing that we… you know if you go back and look at 2008 and you ask people, what do you wish you would have done when you go back and look at your investments and they say, I wish I would have invested more. The market was down, everybody was scared, why didn't I buy more and that's exactly like what you were talking about Bryce. You can have that regret aversion and it could cause you to miss investment opportunities because of that fear of you know lose essentially losing money on paper and your portfolio being down in value. And this is why you should focus like you said on the long-term aspects of it and we nail on it so much but it really is so critical to look at it long-term and even though as much as we mention it, when the time does come, when the markets do start to take a turn, it's very hard for some folks to get over that and to be able to look at the long-term thing because they're so focused on the short-term. They're so focused on well I've worked so hard for this money and I'm like I get that but we have to look at the long-term reward of this. When we go back on my iPhone, I can go back and look at since 1984 what the stock market's done. Even though 2008 was a huge thing, it's tiny compared to that… it's tiny on that graph compared to where we're at today from not even 20 years ago. That huge crash that we had that a lot of people lost a lot of money but in less than 20 years, just the growth from that has been incredible. Absolutely and we don't even have to go back to 2008 to see an example of this in action. Take March 24, 2020 into account. The market going down 33% or so and it was back in 30 days and above and back to attempting to break new highs not even in a year later. Now, the focus as we've already alluded to is you have to focus on long-term benefits of your decision-making when it comes to your investment philosophy and you have to accept some portion of risk and when we talk about risk, it's the volatility of the price movement in the stock market. It's being able to weather the 90s stock bubble in the 08 financial crisis in the 2020. These things are going to continue to happen over and over and over again and you can allude some of the emotional factors are causing some of the volatility but you will still have volatility in the market no matter what. So, having an ability to accept risk will keep you on the discipline plan that you have already stuck to and mitigated to eliminate greed and fear. Some of my favorite investors say that they're not focused on the loss of capital, they're focused on the permanent loss of capital. So, what that means is they're not looking and getting scared at what are the short-term fluctuations here but they are taking into consideration good investments to avoid that level of risk where it can go down to zero. What Ishmael is saying folks is you only lose when you sell. Absolutely, if you invest $100 and the market goes down 10% and now it's only worth $90 and you sell, you've locked in that loss. You've actually lost money because that $90 just sitting in cash isn't going to get back up to $100. But if you let the market ride out and it recovers, then you really haven't lost anything. It's just been on paper as I alluded to earlier ago. The last point, the last emotional factor we'll discuss on this episode would be overreaction and underreaction. So, it occurs when an investor responds too strongly to new information and then while underreaction is the opposite, so not responding well enough. So, an example would be on the overreacting side, I want to get out, I want to get into bonds, I want to do it right now, sell all my stocks, go right into bonds, all in the bonds. That would be in my mind an overreaction which that would lead to a poor investment decision because you're not taking into account your horizon, your investment horizon, what your goals are, what your objectives are, what your goals are. So, underreaction is the opposite of underreaction. You're not taking into account your horizon, your investment horizon, what your goals that you were trying to accomplish. This is just in the short term addressing what you think emotionally is an issue with the market and your portfolio and that will lead to poor portfolio performance. This one just goes back and I feel like this is a perfect one that ties in the last two that we talked about. An overreaction would be to dump all of your cash in there because on a day-to-day, you're just seeing the market go up and up and up. But then doing it on the other side of it where if you're seeing in a week the market go down, you might say, you know what, I'm going to sell out out of every single thing. And when it comes to the underreaction portion of it, that's failing to make moves when they're critical. If you have extra cash just sitting in the bank and the market's down, well, let's start to dollar cost average like we talked about, get some of that money working for you long term while the market's down, while everything's on sale. What kind of strategies, Bryce, can people take to avoid this overreaction or underreaction? Basically, it's similar to the last two strategies where you need to strive a balanced approach while you're weighing new information. But really, the help of a financial professional is going to help you accomplish all three of these strategies. But when weighing new information comes into play as an everyday investor, you have to be careful what that information is provoking. Is that provoking an emotion out of you or is that provoking an opportunity to invest more of your money? Like Ishmael said earlier, you have extra cash just sitting there in savings, not doing anything, and the market's down, that would be different than you're watching the everyday news and this XYZ event happens and you need to get X out of this or that. That's not a balanced approach and that's not weighing new information. That is emotionally reacting to information. And realizing in your mind how to remove yourself from that type of bias is what's going to make you more successful over the long run. One feller that I really enjoy listening to is Howard Marks, CEO of Oak Tree Capital. No, I shouldn't even mention that because then Vantage is going to flag me. Let's see. I don't really have anything to add on that, Bryce. So, as we move forward, there is impact of investor psychology on market behavior, which is why you're seeing some of the volatility on a day-to-day basis based on speculation or for whatever reason. And investor psychology, it affects the individual investors. It contributes to the broader market behavior. So, that would be seen in market anomalies, bubbles, and crashes, right? So, a market anomaly would be patterns or occurrences that would contradict what we would see as the efficient market hypothesis, which we've outlined in earlier episodes. So, and essentially, it just states that the markets are always perfectly rational and efficient. So, anomalies similar to, which are called the January effect, momentum investing, suggest that some investor psychology can create inefficiencies in the market. And understanding these anomalies, it helps investors identify what are potential opportunities and improve the investment strategy that they've already fine-tuned in the first place. That was good. You got nothing to add. Less so, Bryce. Another impact would be the market bubbles and crashes. We've already spoke about the 08 crash. We've talked about the COVID crash. We've talked about the tech bubble in the 90s. So, market bubbles occur when the asset prices are overvalued, and they can be driven by investor enthusiasm or irrational exuberance, like we talked about, overreacting on an uptrend, for instance. And market crashes, on the other side, are sudden severe declines in the asset prices. So, those are often triggered by panic selling. So, both of these are versions of overreacting versus sell everything and flee the bonds or buy everything because the market will still go up forever. And it's fueled by investor psychology. So, it's highlighting some of the important emotional factors we've just outlined and how they come out in biases in the investment process. If you know anything about, if you've seen the movie, The Big Short, that's based on real life from the 2008 financial crisis, there's a guy out there named Dr. Michael Burry. He was a hedge fund feller who made a lot of money in 2008. And I think there was one thing that really tied into this, which was that last year, and I think it was in the fall, it was like November, around that time frame, he tweeted for everybody to sell out of everything. Because, actually let me reword that. In 2008, there was a feller by the name of Dr. Michael Burry, who was a hedge fund portfolio manager and he made a lot of money shorting the housing market in 2008. And so everybody looks at him as this market genius, this market wizard who knows every little thing about the market. Well last year in the fall, he tweeted for everybody to sell out of everything and the market went up for like two months in a row and then he tweeted and said that he was wrong. So it goes to show you that no one really knows what the markets are going to do. And every single day we see somebody on the news that's predicting a huge market crash and the market crash of the century. And they've been saying that for the last 20 years, but then the year that we have a crash, they say, see I called it back in this year, I knew that the market was going to crash. I'm like, well you've been saying that every single year, just now this year, it happens that we have a downturn and now all of a sudden people think, well that guy got it right. He must know what he's talking about. And as you can see, even the guy that made a ton of profit in 2008 got it wrong by saying, you know what, I don't know everything about the markets. I don't know when they're actually going to go down all the time. Absolutely and mitigating through all of this stuff, which is provoking emotion, which is what he was trying to do with social media to make his position right, is another form of the overreaction, emotional bias. But being able just to identify what it is and then being able to hold in your mind your strategy and in lockstep move through all the noise of the outside market, you're essentially making yourself an efficient investor. Now let's move to the strategies for managing these investor psychology issues, all right. So there's four strategies that I feel are most useful and it would be diversification, long-term investment approach, using financial professionals, and having education and self-awareness. So the last two points, using financial professionals and having education and self-awareness, those two are accomplished by you simply listening to this podcast right now in my mind. You have two guys that are studying for their CFPs that are holding a platform for educational purposes to help the everyday investor. Right now, if you're listening to this podcast, you are accomplishing strategy three and four. So you're doing great in those aspects. But what we need to focus on for the remainder of this show in my mind is focusing on the diversification and long-term investment approach, which we've slightly touched on at the beginning of the episode. That was good, Bryce. That was good. Hold on. I'm just gathering my thoughts. Just go with diversification. I'll do long-term approach. Okay. The other... Yeah, Bryce, you couldn't have hit better on those bullet points. By just listening to this episode, you're covering three and four. The two other ones are the diversification and then the long-term investment approach. Charlie Munger said that you don't need to have very many investments to do really well in investing, which is great. And he actually, he was against this huge idea of diversification by saying that it was for the know-nothing investor. And then here came Warren Buffett at the same exact, just like a minute right after he said that saying, but that's completely fine. And I think it is completely fine for the know-nothing investor because a lot of investors are know-nothing investors. And what they mean by that is they're not sitting down reading annual reports every single day, learning about the fundamentals of a business, listening to earnings calls and conference calls. They're just wanting to have their capital work for them in some way and I think that's what an index fund or a mutual fund can potentially do for you by saying, hey you know what I don't know enough to know about this company but I know that if I buy the whole market, I can do alright for myself over the long term. And Jack Vogel from Vanguard, he had a quote that he said, instead of trying to find that needle in the haystack, just own the whole haystack and you'll do alright over the long term. And that quote to me means a lot because it's okay to be the know-nothing investor. You don't need to sit down and try to read that annual report to be able to you know try to learn on whether this company is a good company to invest. What if you don't even know how to read their statement of cash flows, their balance sheet. That's what these other you know investment vehicles allow you to do is to say hey it's okay to not be a know-nothing investor but I can just own the general market and get my money working for me in the long term. And that's what Buffett alluded to that, hey that's a completely okay and rational thing. Don't think that you need to be able to go out tomorrow and learn how to read that statement of cash flows. It's okay to just buy a fund that owns a lot of these investments in there for you that can begin to get your capital working for you. Absolutely and well a well-diversified portfolio is going to mitigate a lot of impulsive decisions an everyday investor might make. An example I would have, I was on a call with a client and they were working their way down through the Magnificent Seven, the top stocks in the S&P 500 of which to own. And as they were working through which ones they would rather own, it eventually, it's obvious you own the market just like you said. You have an indexed strategy which we are huge on, own the whole market because you're being impulsive on trying to allocate a specific amount of dollars to the best performing growth stock. It's never going to be effective in the long term based on trading costs, based on your emotional factors that we just touched on. And I think market volatility needs to be an essential factor in long-term wealth generation. Now, when I say long-term though, we need to make sure it's focusing on the potential growth on the potential growth of assets over the extended period of time and eliminate the timing of the market that everyday clients sometimes try to do. And this strategy, I think it just mitigates the impact of the emotional factors, right? Just because over the long term, you don't see volatility in the same light as you would if you were trying to make this decision for tomorrow or the next week or even the next year. They're more likely to fall in line with your long-term goals, the investment decisions you are making, and it just gets you over the hump of these emotional pitfalls. That was good, Bryce. You got nothing to add. And those are the four strategies that you need to employ. And if you've made it all the way to the end, congratulations. You have accomplished points three and four, seeking help with financial professionals and education and self-awareness. Now, making sure to have a diversified long-term strategy, that's going to play a significant role. in your success over the long term, in my opinion. And understanding these two strategies is almost as effective as understanding the cognitive biases and your emotional factors that's going to shape your behavior and is going to prove critical for making informed decisions and avoiding pitfalls. Absolutely. Well, I think this was a great episode. Like I said at the beginning, guys, you can have a great plan and a great investment, but the behavioral side of this and the psychological components of this are just as important. You want to make sure that you know what you're investing in. You want to make sure that you have a general knowledge because not only is that going to help you to be able to communicate with your advisors, but it's also going to help you to be able to communicate with your clients and your business partners and help you to be able to communicate with your advisors better, but that's also going to be able to allow you to stay buckled in on these troubled times in the market. Absolutely. Ishmael, where can somebody reach you at? No, hold on, I have to say that. Absolutely and as we move forward to the final point of… God, I need to say that again, hold on. I'm having trouble summing this up. Don't say absolutely anymore. Yes, I know, I keep saying that. Hold on, one second. Give me two seconds. Thank you guys for listening. We appreciate our audience and our listeners. Ishmael, if someone needs to get a hold of you and seek your advice as a financial professional, where can they find you at? You can reach me at 208-337-3271 or visit our website at parker-advisors.com where you'll be able to see both Bryce and I. And Bryce, where can the clients reach you at? Where can prospects reach you at? If you need to send me an email, go ahead, Bryce at parker-advisors.com. You can find my email on the Parker Advisors website. Feel free to give me a call, 208-697-2202. And we will be back with part two. We'll move forward on the behavioral finance in our next episode going through our cognitive biases which should pair well with these emotional factors. Thank you, guys. Have a great day. Goodbye, everybody.