Why do we invest money?
Usually because we need to put it somewhere whilst we are not spending it, but whilst we are not spending it, the real value of our money is being eroded by inflation. A return to minimise this threat over the longer term is required and therefore many people invest in the stock markets, because, over the longer term these will usually provide better returns than investing in deposit accounts.
Unfortunately, there are two big factors in human’s psychology which drives the markets and our investment decisions; fear and greed.
It would be nice to think that those on Banker’s Hill make investment decisions based upon economic data and company research, but in reality, most are just rolling the dice.
How much is a company worth? It all depends on the mood. How often have you heard the term ‘market sentiment’? Companies can be massively overvalued, or massively undervalued. It depends upon the sentiment.
For example, on 1 March 2017, shares of Snap, the owners of Snapchat rose by 44% on the first day of trading, valuing the company at almost $30 billion, even though in 2016, its losses were $404 million. (Source: BBC News 2 March 2017). On 16 January 2019, the company was valued at $8 billion. (Source: CNBC.com 17 January 2019).
Sound economic, company and market research, or fear and greed? You decide.
The investment industry exploits this fear and greed and focuses consumers attention on past returns, and making investments seem very complicated, they do this along with the financial press, who make millions from advertising financial products.
Paul Armson, in his book How Much is Enough, calls this ‘financial porn’.
‘Financial journalists want you to be looking for the next new thing. They want you to be unhappy with your returns.They want you to be searching for a better investment. Why? So, they can keep advertising more of that stuff at you! All the while raking in millions in advertising revenue.’
The investment industry sells you more and more unnecessary products, laughing all the way to the bank…
It is not just professional investors who are prone to make investment decisions based upon fear and greed, the same psychology can also have an influence on the public.
The greed. Potential investors see returns (and try and chase them but these are actually past returns, which have been and gone and are probably never coming back. (Just ask Mr. Woodford’s investors). They don’t give any thought to how much return they actually need to achieve and have little consideration of the risks involved. Until it all goes wrong…
The fear. Many people, quite understandably, want to have very little to do with the investment markets and therefore keep all their money on deposit, little realising that their wealth will be eroded by inflation over the longer term. Almost a guaranteed loss.
How can you break away from this psychology?
By using a good financial planner and cash flow modelling, you can get a good indication of how much return you need to achieve your desired lifestyle, without the fear of running out of money.
If you are unlikely to ever run out of money, why take an unnecessary risk to get more, when you could end up with less? All you really need to do, over the longer term, is to match inflation. This can be achieved simply and cheaply by using low cost passive funds.
But these aren’t as exciting as specialist managed funds and so sell less newspapers and magazines...
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