In a previous article, I asked you to imagine your perfect summer holiday at your dream destination. Now imagine that same holiday while having a bad bout of the flu. Your body is aching, your head is pounding and you are running a fever. I hardly need to explain why this holiday would turn out to be a miserable one. Why is this? The answer is simple: your emotions are negatively influenced by your illness.
In my opinion, very few reports by analysts and economists ever take one of the most important aspects of investing into consideration: the impact of emotions on investments. However favourable or well-priced an investment may appear, if illness causes you to feel miserable, it may seem like a poor investment.
It has been a long time since this phenomenon has been more obvious in the share market than in the last five years. The world economy has been “flu-ridden” since 2009. With the markets booming lately, emotions are definitely running high when we take a look at current market ratings. Comments are flying around about how the markets are trading higher because of lower interest rates and how things may just be different this time.
If your investment choices are not based on probability, they are based on eagerness or fear (emotions) and this places you in danger of seriously burning your fingers. We saw an example a mere week or two ago when on Monday, the 4th of May 2015 to Thursday the 7th of May, when the local share market declined by 2.2%, only to increase by over 1% at the end of the week (8th of May). This great volatility is a clear indication that emotions are running high and that they are playing a massive role in market movements.
Emotional investment can seldom be better explained than by looking at one of my favourite local shares, MTN. After the company released great results year after year, MTN’s share price doubled in the three-year period from September 2011 to September 2014 with a PE of 17, still not trading at a rating that is too exuberant. Suddenly, we had the oil price collapse in our hands, and with MTN’s big exposure in the oil-producing Nigeria, investors felt that this may have a very negative effect on the company, resulting in a 24% decline in share price from levels around R260 to just under R197 only three months later.
Graph 1: MTN with a 200-day and a 50-day Moving Average
Emotions (fear) made way for good financial news, pushing the share price back to over R240. I have no doubt that investors certainly did not see this as a joyride and that any investor who purchased MTN in September 2014, experienced the following emotions:
- Denial: “Why did I buy MTN?”
- Remorse: “How could I have been so stupid?”
- Shock: You go to bed after the MTN share price had already declined by 10%, in the hopes that if you wake up the next morning, it would all have been only a nightmare.
- Obsession: You keep fretting about the capital you used to own.
- Gambling: Now that MTN has decreased by 10% since September levels, you decide to borrow money to trade yourself out of your loss, only to find the price dropping by a further 14%.
- Fear: With prices below R200 and at nearly a quarter of your capital lost, you decide that you have had enough and sell everything.
- Regret: At current levels, you would be utterly disappointed in yourself, thinking “If only I hung in there a little bit longer”.
This is where most investors (including professional investors) make mistakes, as investments, especially in shares, must be done with a long term view in mind.
One thing remains for sure: Emotions and investments do not go hand in hand.
The opinions expressed in this document are the opinions of the writer and not necessarily the opinion of PSG. These opinions do not constitute advice. Although the utmost care has been taken in the research and preparation of this document, no responsibility can be taken for actions taken on information in this blog.