Herd mentality in the field of market investment can have disastrous consequences

Heights always scare us. Suppose you are riding a giant wheel. When do you fear more? When you are at the top? Or when you down? At the top, right? However, when it comes to investing in equity, people adopt a different attitude. For example, most people are confident of investing in stocks when the sensex is at 21,000, compared to when it was at 14,000 level. Legendary investor Benjamin Graham in his book The Intelligent Investor writes that “the Intelligent Investor realises that stocks become more risky, not less, as their prices rise—and less risky, not more, as their prices fall. The intelligent investor dreads a bull market, since it makes stocks more costly to buy. And conversely (so long as you keep enough cash on hand to meet your spending needs), you should welcome a bear market, since it puts stocks back on sale”. We all know what is stated above is true. But if we behave otherwise—feel bullish when markets rise and feel bearish when markets fall—then we should place ourselves in the category of “Less Intelligent Investor”. In real life, most of us feel confident to invest at 21,000 and fear equity markets at 14,000. Most important reason for the above mentioned behavior is the anchoring effect. We tend to link our decision to previously demonstrated number. Suppose the market has moved from 8,000 to 21,000 to 14,000. Firstly, at 21,000 levels, we will have 8,000 levels in mind and hence we will feel euphoric. At 14,000 levels, we would have 21,000 levels in mind and hence will feel dejected. At 14,000 levels we tend to forget about 8,000 levels. Having anchoring effect is like driving the car only by watching the rear view mirror. If we keep driving the car by only by what is in the rear view, we can only see what has gone by. This way we are surely going to bang the car somewhere. To move ahead, we must look what is ahead. Rear view mirror only acts as guiding post. Further in life it is always prudent to buy required goods and services at the least possible cost. When equity markets fall, it gives us opportunity buy stocks at lower prices. However, we sell our stocks when the prices are falling (low) and we feel safe when the prices are rising. As Anthony M Gallea aptly put, “Investing is a strange business. It’s the only one we know of where the more expensive the products get, the more customers want to buy them.” Since most investors buy at higher levels and sell at lower levels, The intelligent investor will have to behave contrary to the herd. It is better to remember Sir John Templeton’s words: It takes patience, discipline and courage to follow the contrarian route to investment success: to buy when others are despondently selling, to sell when others are avidly buying. Lastly in words of Benjamin Graham, “Individuals who cannot master their emotions are ill-suited to profit from the investment process.”