The Emo Cycle of Investing
All of us have long-term needs. Since voluminous studies, the best one by Jeremy Siegel entitled Stocks for the Long Run, have proven that stocks provide the highest returns in the long-term among all asset classes, then we should all be invested in the stock market. Unfortunately, only less than 1% of our population is taking advantage of this asset class.
And this is with a reason. No matter how rational we think we are, we are not. We are all emotional beings who almost always behave not based on logical decision-making but based on our “emo.” For instance, why do we see a lot more people parting with their hard-earned money so they can invest in a business partnership with a friend, relative or even friend of a friend, and so on, rather than invest in listed stocks? Is your prospective business partner better than the taipans of our listed companies, especially the blue chips? No! But it’s because you feel that the value of your investment in the stock market is constantly moving up and down, up and down, as reflected in the ticker tape. But may I point out to you that the same thing happens to your investment in your business partner? Once a portion of your initial investment is spent, there is a change in your investment value. The only difference is that the value is not constantly reflected, as it is not a listed company.
Given the above, what must the regular Juan do in order to avail of the benefits of the asset class that provides the highest returns in the long run?
Aside from understanding the principles of stock investing, he should also understand the Emo (or emotional) Cycle of Investing. Let me explain in simple terms.
1. Reluctance. Whenever I ask someone why he is not investing in the stock market, the most common answer is the notion that it is a risky business. He is reluctant due to lack of knowledge, experience, and horror stories of losses heard from others. The Loss Aversion Principle in Behavioral Economics (B.E.) is at play. Because we experience losses more strongly than gains, we just try to prevent losses more than we try to make gains.
2. Optimism. Then he hears a good number of happy, usually yabang, stories about making money in the stock market and he changes his loss aversion from aversion to losing money, to aversion of missing out on the opportunity. So he is now thinking about finally investing in the stock market.
3. Excitement. At first, either due to careful studying or beginner’s luck, he makes decent profits from his maiden investments. He gets excited and talks to his friends and family about his gains and encourages them to join him.
4. Exuberance. As he makes more money, he changes his initial asset allocation to increase his stock portfolio. He even gets overconfident that he tells his family and friends to just let him invest their money for them. He is an instant star fund manager! The more aggressive ones even take up loans to increase their portfolio. All daw theories (“tataas daw!”) are subscribed to. And since herd mentality (another B.E. principle which is joining the bandwagon or doing what everybody else is doing) is at play here, he feels safe. He is experiencing Irrational Exuberance – a term originated by former Fed Chairman Allan Greenspan and used as the title of a bestselling book by Nobel Prize winner Robert Schiller.
5. Denial. Reality catches up. He is no Warren Buffet after all. It’s just that the market trend was really on the rise in the previous phase, but of course, he doesn’t see it that way yet. He still insists that his stock picks and timing are impeccable. In fact, he buys more in order to average down. He is also somehow affected by another B.E. principle namely Sunk Cost Fallacy (becoming psychologically invested in costs already incurred regardless of what the current and future costs and benefits are.) In other words, he continues to “throw good money after bad.”
6. Fear. Reality sets in and he finally acknowledges that he is no Warren Buffet after all. He is now scared as he sees his portfolio value shrinking each day.
7. Desperation. He now starts pulling his hair, “Why did I let those profits get away? I should have sold earlier!” He doesn’t know what to do at this point and he does things, sometimes selling, sometimes doing quick crazy trades, just to put his portfolio back in the black.
8. Panic. This is probably the most emo of all the stages. He is not able to eat well and sleep well at night. He is consumed by the losses and feels hopeless and at the mercy of the market. Because he is on panic mode experiencing ego depletion (a B.E. principle that says that humans are unable to make sound decisions because of physical or emotional fatigue), he continues to make really bad decisions, further worsening his situation.
9. Capitulation. Capitulation means surrender. He just reached his breaking point, “Sell!” All he wants is to be out of the market, regardless of price.
10. Despondency. After selling his position, he says, “That’s it! I’m done with stocks! Look at the index, it’s thousands of points down from the happy days! Ayoko na!” And he resolves not to enter the market again.
11. Depression. He is now crying, sulking and praying hard, “Lord, why did you allow this to happen to me?” He stops seeing his stock market buddies, who at this point, he considers as bad influence in his life.
12. Apathy. He is done with crying and sulking. But he is totally indifferent and unresponsive to any good news about the stock market.
13. Hope. Eventually, he realizes, “Hey isn’t the stock market really supposed to come in cycles?” Then he starts to think of the opportunities that await him.
14. Relief. He sees the market turning positive again,“Look, some of my previous stock picks have come around!”
Our Mr. Investor regains his confidence little by little. The cycle is about to start all over again. But first, he starts with the first phase Reluctance and so on and so forth.
The question is “Can we actually plot where we are now?” Some self-proclaimed gurus will say yes. As for me, I wish I knew when phase 4 Irrational Exuberance is so I can dump all my position. I wish I knew when phases 10 and 11 Despondency and Desperation are, so I could sweep all the selling, but I can’t, and admittedly so. I don’t have a crystal ball. In fact, even with the clearest of clues, I am sometimes confused if it’s a just a correction or the start of a new trend. But am I happy with the returns I get from the stock market? The answer is a resounding yes!
For over three decades now, I’ve had my share of hits and misses. But what has kept the returns good are the discipline, consistency in investing and asset allocation vis-à-vis our goals and stages in life. Awareness of the existence (not the precise timing) of the phases in the Emo Cycle of Investing has definitely helped me follow though with my investing in the stock market, an important component of High FQ.
So here’s my call to all stock investors out there, and also the 99% of our population who remain un-invested in the market. Invest in the stock market because it is the asset class that provides the highest returns in the long run, and we all have long-term needs. For you to make the most of your investing, remember that the market does not move in a predictable straight line. It moves in cycles!
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ANNOUNCEMENTS
The series of workshops of Security Bank’s Smart Saver Kiddie Camp continues. Talk 4 will be on June 10, 2016 at the Books and Borders Café, McKinley Hill, Fort Bonifacio, Taguig City.Registration starts at 9:00 am.Send email to mcabusora@securitybank.com.ph to reserve a seat.
The next talk will be at the Kiddopreneur at Shangri-la Mall on June 26, 2016. Watch out for the next schedules of this Workshop Series.
Rose Fres Fausto is the author of bestselling books Raising Pinoy Boys and The Retelling of The Richest Man in Babylon (English and Filipino versions). Click this link to read samples - Books of FQ Mom Rose Fres Fausto. She is the grand prize winner of the first Sinag Financial Literacy Digital Journalism Awards. Follow her on Facebook and You Tube as FQ Mom, and Twitter & Instagram as theFQMom.
ATTRIBUTIONS: I don’t know who originated the 14 Phases of Emotional Investing. I’ve heard this in talks and read in books and articles. There are slight differences in stages in the materials I’ve encountered. I came up with the 14 that I think best describe the general sentiments and injected them with Behavioral Economics principles. Images from clipartbest.com, symbols-n-emoticons.com, pinterest.com, clker.com, wpclipart.com, albertvillefbc.org
