Investing Intuitively.
Sale! Sale! Sale! The mobile that you really wanted is on sale. Do you think twice before buying it? No. Do you doubt its credibility now? No.
Now let’s talk about investments.
The stock of that company with really good financials and management has fallen. What do we do? We see the falling price, get scared looking at the loses and miss out on the opportunity of discount.
Unlike while buying a mobile, here we have the opportunity of buying the share at various prices, at every low, to average our cost.
The markets may bring a good company’s stock down but its performance will surely reflect in its price later on. We wait for the stock price of a company to move up to believe that it is good when it should be the other way round, we should first understand about the company’s management and financials and when that checks all the boxes then we should buy that stock and market going down is just increasing your purchasing power, you can now buy more for less.
Let’s take another example.
You have two friends: “A” and “B” who want to borrow money. A has a great credit score and is very reliable whereas B is not. A is willing is to pay an interest of 5% p.a. whereas B is willing to pay an interest of 7.5% p.a. since his credit score is not good. Who will you be more comfortable lending the money?
A, right?
A little less interest earned is better than principal burned.
But when we are looking at fixed deposits, we opt for the highest interest paying fixed deposit because we all have always heard that fixed deposits are safe. We do not try to understand the difference between the different interest rates. The higher the interest rate, more the risk premium.
It is said that “Precaution is better than cure”, so why not be safer by investing in instruments of companies/banks having better financials than in something that looks attractive but does not have the supporting financials to back the offers provided.
When we are thinking about purchasing any other product, our intuition works perfectly as to buying a good product at a lower price is beneficial but when it comes to investing, we do not follow the same thought process.
When we invest in equity or debt, we invest in the company/ bank whose stock or paper we are purchasing, so why not opt for the one which we know is going to grow.
“Invest today in what you believe has a tomorrow.”
We often feel the pain of loss more than the joy of gains. We all want to avoid losses but, in the process, we forget to maximise gains. For example, you have two apples: one rotten and one fine, which one do you throw away?
The rotten one?
Now assume you have invested in two stocks: “X” and “Y” equally. Stock “X” goes up by 50%, while stock “Y” goes down by 50%. What do you do?
You do not sell stock “Y”, you keep hoping it will go up because you want to avoid losses. This loss aversion bias keeps us from making rational decisions which would have been intuitive had it been any other product.
The above example tells us about how we react to price but the value of the stock is more important than the price. Two stocks may have the same price but that does not in any way denote that they are of the same value. Had it been any other product, we would think if the price justifies the value of the product.
When investing, we do not treat the investment instruments like any other product that we purchase. Our intuition and rationale take a different turn and our decision-making process is impacted by it.
If we simply start treating investing as any other product we purchase, it would help us in taking more rational decisions intuitively without being impacted by biases.
Article by:
Anjali Sharma — Anjali is a Chartered Accountant by qualification and has been associated with Sapient as a Research Analyst for over 2.5 years. She is based out of Guwahati and is a keen reader. She also likes playing card games & badminton.
