“The first duty of a man is to think for himself.” - José Martí
Positive sentiments during the post-war era attracted a large number of new investors to the capital market. Many investors were able to reach their financial goals while a few others did not earn profits as expected. Several factors would have attributed to the above stated. Today’s article will focus on the mistakes made by new investors who lacked individualism when investing in the market and followed investment decisions of high-net-worth investors without sufficient reasoning. Differently stated, a form of behaviour referred to as herd behaviour in behavioural finance.
“Most people say that Shakespeare rocked merely because most people say that Shakespeare rocked.”
- Mokokoma Mokhonoana
Herd behaviour is the tendency for individuals to imitate the actions (rational or irrational) of a larger group. There are a couple of reasons for this form of behaviour. One reason is the common rationale that it’s unlikely that such a large group could be wrong. After all, even if you are convinced that a particular idea or course or action is irrational or incorrect, you might still follow the herd, believing they know something that you don’t. This is especially prevalent in situations in which an individual has very little experience.
This theory explains why certain investors didn’t earn profits as expected. These new investors entered the market when the market capitalization and market turnover were increasing rapidly. Moreover, return to investment was relatively short term (at times even a few days). Almost all stocks were lucrative. In such a context, new investors were lost for investments as all investments looked profitable. Eventually they based their investment decisions on market rumours that were in most situations determined by investment decisions of high-net-worth investors.
When the rumour of a high-net-worth investor purchasing a stock enters the market, the rest of the investors would blindly purchase the stock without sufficient reasoning or research.
There might have been situations where it was profitable, yet the risk of reducing the return to investment is higher when you blindly invest in a stock simply because a high-net-worth investor did so. The next section will spell out how the herd mentality could reduce profits.
What went wrong?
“Do not repeat after me if you do not understand the words. Do not merely put on a mask of my ideas, for it will be an illusion and you will thereby deceive yourself.”
- Jiddu Krishnamurti
Differences in investment goals
The key towards successful investment is gearing one’s investment decisions based on his/her financial goals. Financial goals are shaped by risk appetite, rate of return, holding power, etc. Differences in these variables would bring about different financial goals between high-net-worth investors and the rest of the investors. Table 1 explains the degree of difference in investment goals.
When a high-net-worth investor intends to enter the director board, return to investment in terms of monetary gain is not given prominence. The investor might even consider entering even an overpriced stock. However, investment goals of medium/small scale investors are geared at monetary gains. Thus, it explains why a certain investor, who blindly follows, doesn’t obtain expected returns.
Trapped in market irregularities
There were times when small/medium scale investors based their decisions simply on market rumours of certain high-net-worth investors purchasing shares. This increases the demand for the stock and pushes up the price. Even though the high-net-worth investors purchase shares at lower levels, the majority of the investors would purchase these shares at higher prices, far above the intrinsic value of the stock. The situation intensified when the high-net-worth investors silently and strategically exited the stock while medium/small-scale investors continued to purchase at higher prices.
These investors blamed the market and other stakeholders on their losses. Yet, it is important to bear in mind that it is their ignorance that fuelled such irregularities. The regulator can only educate you and warn you but cannot force you to make the correct decision. It is the duty of the investor to think and act wisely.
Missed market opportunities
The market boom was followed by a market correction that brought about lucrative investment opportunities. Most of the stocks were trading far below its intrinsic value. The herd mentality once again prevented investors from reaping the benefits. They were guided by market rumours that were over exaggerated and backed by hidden agendas.
Is individuality key to successful investments?
“Attempt to be fearful when others are greedy and to be greedy only when others are fearful.” - Warren Buffet
The above quotation clearly states the mentality of successful investors. The success of Warren Buffet does not lie on a well mastered skill of blindly following the herd. The pillars of success would be patience, knowledge, ability to not only think out of the box but also redesign it and last but not least discipline. You have to be yourself and be focused on what you are aiming at. You should be able to act in the market as an individual who is capable of independently comprehending market performance and acting accordingly based on his/her own judgment.
You can learn from successful and high-net-worth investors but never imitate unless it is in line with your expectations.
Lessons could be drawn from the behaviour of foreign investors. They exited the market at a point local investors were blindly investing and once again entered the market at low price levels when the market was experiencing a correction in prices. As discussed above, the herd mentality resulted in local investors missing the opportunity.
A successful investment strategy is a homegrown strategy based on one’s financial credibility, financial expectations, risk appetite and holding power. It is also important for one to act with an open mind backed by creativity and knowledge in order to identify the hidden opportunities.
How do you design your very own investment strategy?
This section will focus on the areas investors should look sharp on when designing a winning investment strategy.
“Sound strategy starts with having the right goal.” - Michael Porter
It is vital that you have clearly defined goals formulated based on your needs. Invest only if investment opportunities go in line with your goals. Don’t change your goals based on short-term market fluctuations. Similarly, don’t aimlessly hold on to a goal if it is not feasible. However, well designed your goal is it is important to look at the results often.
“An investment in knowledge pays the best interest.”- Benjamin Franklin
New investors blindly followed the investment decisions of others due to the lack of sufficient knowledge. Investing in the market is not an easy ride. Your profits greatly depend on the hours of homework. It is true that your investment advisor would guide you but the final decision is made by you. Thus, it is vital that you’re equipped with relevant subject matter. Familiarize yourself with related financial reports and research. It is equally important for you to update your knowledge.
“Earth provides enough to satisfy every man’s needs, but not every man’s greed.” - Mahatma Gandhi
A strategy should not be driven by greed. It should be designed in a manner by which you exit a stock when you obtain an expected rate of return.
“A man is what he believes in. Believe in yourself and make wise decisions in the market.”