Market prices falling? – should you exit your long-term stock specific portfolio too?
Sharp falls in market prices generally make headlines across all media. And no sooner when the index falls, predictions of more doom start pouring in from all corners. Clearly, the mood is that of panic and fear. And we won’t blame the investors if they are unwilling to touch stocks even with a six-feet pole. Simply because our brains are hardwired to make us run from danger at the first sight of it. And when it comes to investing, nothing can be more dangerous than seeing stocks suffer violent declines in a matter of hours.
What are the key factors that you consider while investing in any stock? Undoubtedly fundamentals, valuations and management quality would rank high amongst host of other variables. Basically, these key factors rule your decision to buy or sell. While this seems to be pretty much true on paper the reality is quite different.
The truth is that most of our investment decisions are governed by fear! And fear arises from our emotions about how we perceive others will react to a given situation. Let us explain how this tenet rules our sell decisions.
Generally, people intend to sell when fundamentals deteriorate. That’s one angle to it. However, the actual action of selling culminates when fear grips us of losses we may incur by not selling.
Take the example of a stock which is on a declining trend. While fundamentals may not warrant a decline from certain level the stock may still go on to reach new lows. The reason is people start selling out of fear. A person who is scared, sells assuming that others are also scared. This brings the stock price below its fundamental value. In short, fear results in selling too soon. And this happens because an individual bases his decision to sell by perceiving other people’s state of mind on the stock.
Now let us see how fear rules our buying decisions. Head back straight to 2008 when the credit crisis was at its peak. Most stocks were trading at dirt cheap valuations then. Yet there were very few people who stuck their neck out to buy. Why? The answer is again fear. And this happened because their thinking was based on the perceived situation in the market place. Outside environment created a sense of panic which restricted individuals to buy. But those who overcame fear made a pot of gold out of their investments.
Thus, it can be seen that FEAR makes us take decisions which are not favourable over the long term. However, overcoming fear does not mean you have to be contrarian. It means executing the decision if you feel the process you followed to arrive at any decision (buy or sell) is right.
Stay invested without fear when risks are known. In the long-term prices always reflect fundamentals.
“Risk comes from not knowing what you are doing“
– Warren Buffet
Leave a Reply