American retail investors through boredom (and lack of sports betting) are piling into the stock market, and now make up 20% of US equity trades. Most non-professional investors do not use objective analysis – they are driven by emotions and herd instinct - and with one-fifth of the World’s biggest market they are starting to have an effect.
Lockdown. Highest debt to GDP since 1960. Inflation higher than deposit returns. Taxation on the way. Things can only get better...
Emotion & Investment
Back when we were in caves we had two main drives – to survive and reproduce. We still have these powerful drives, albeit they are a bit more sophisticated now with the development of the ‘human’ thinking element – see below. In this context investment is an extension of the survival instinct (having the funds to buy food rather than hunting for it, afford shelter etc); under the second heading of reproduction, this goes beyond sex; just look at how far most parents will go to protect their kids, having produced them.
Psychological Stuff – Chimps and Humans
Different parts of our brains have different functions and medical science can tell which bits we are using at any one time by looking at the changing blood flow within the brain. The two main parts that affect our investment decisions are the emotional primeval bit (freeze, fight or flight – popularly now called the ‘chimp’ derived part) and the ‘human’ bit – the logical analytical ‘Spock’ like part. The first part was essential for keeping us alive many years ago by reacting quickly and the second is responsible for our development; interestingly analysis of blood flow indicates that the Chimp bit is often dominant.
Chimp / Human / Perception stuff
Aversion to loss - up (in value) is good but down hurts lots more. Emotionally people typically experience a level of pain when they lose money that is about twice as intense as the pleasure they experience when they make money. This may not come as a surprise but it explains why market falls are extended even when conditions have improved – people remain frightened.
Knowledge conquers fear. In spite of my comments in the last paragraph, people do get used to new stuff and as they learn more, they are less intimidated by it. In a financial context, as people become wealthier and more experienced in financial matters, they are less likely to react in a knee jerk fashion to market volatility – they move from chimp reaction to human thinking. The more financially knowledgeable you are the more likely you are to take more risk.
Herding: this is the instinct to follow others, it is evident when people are suspicious of the restaurant that is empty and instead queue at the one next door which is full. Safety is the primeval driver here – the chimp being part of and supported by its troop. This can have a real effect in driving market behaviour given increasing numbers of non-professional investors.
Risk perception is interesting. What is the world’s deadliest animal when it comes to killing humans? Most people intuitively think of beasts with large teeth such as the lions, tigers etc. In reality though, it is the tiny mosquito that does the most damage. It causes more deaths than virtually any other animal; responsible for about 725,000 human deaths annually. Only human beings themselves come close, with a tally of about 425,000. This is a classic example of our tendency as humans to misunderstand risk and is particularly relevant when considering investment risk.
People tend to think in terms of catastrophic risk – which is happily rare – rather than real and insidious risks such as inflation which currently means that funds held on deposit are gradually going backwards.
Most of the above points have fancy names and there is a lot complex work done analysing investments but I am very interested in investor emotions since the action of individual investors is affecting markets more lately – via herding particularly. Think about how YOU feel about stuff and how your views and actions have changed – because most humans have a lot in common; this is why I sometimes try to think like a normal person, rather than a financial adviser.
Always a silver lining… Post lockdown is the time for your kids to get married; at the moment they can only invite 15 guests, thereby saving you loads. The honeymoon costs will also be reduced with most of the expensive destinations being off the menu.
‘FOMO’ – means fear of missing out, this happens to me when others seem to be being served first.