Why you should avoid crowd mentality

November 14, 2008
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, NAIROBI, November 14 – A number of reasons have been floated to explain the current state of the capital markets. The year started with a period of post election violence. We then had the largest Initial Public Offer (IPO) in the bourse’s history which proceeded to absorb quite a bit of liquidity from the markets.

Leveraged IPO investments coupled with the quick exit of foreign investors went on to dampen prices. Furthermore inflationary pressures have reduced disposable income in people’s pockets. Though we are not directly affected at present, the global financial crisis will in time have indirect consequences to cash flow into the economy.

The overall effect of the above factors has been to reduce confidence in the markets. Investor sentiment is low and hence motivation to spend money is low. If you feel poorer now you will tend to spend less; if your portfolio is showing losses now – realised or not – you will spend less.

If the markets were on the rise and the value of your portfolio was going up, whether it is realised gains or not, you will spend more regardless of whether the money in the bank is the same. Those who are holding positions now and regretting their current circumstance, is equivalent to expectation that you should have foreseen how over one million investors are bound to behave or react at a certain period. 

This is the reason why bottoms or peaks in markets can hardly ever be accurately estimated. A common field of study in the investment world is Behavioural Finance or Economics which is sustained by the premise that when it does come to money, investors are not as rational as they are presumed to be.  Hence why asset prices become over valued in a bubble and undervalued when investors panic.

Everyone is of course worried and it is human nature to do so.  All we can do is control how we react to this worry. Do you rush and panic now or do you focus on the end objective? 

Is the decision you are making now best for tomorrow, best for what your end objective was? People tend to place too much importance on current events, recent market movements, opinions etc that are in fact different from more realistic trends like historical longer term averages and may not actually affect their longer term goals.

It is always advisable to have a plan when dealing with money. Set targets and stick to them unless they are actual reasons why the plan should be changed. Inevitably along the way there will be ups and downs. How you react to them will determine whether your end objective will be met. In some cases, periods like this enable certain objectives to be met faster as you are able to accumulate assets at cheaper prices.
 
Current conditions may temporarily affect certain industries and immediate earnings growth in some companies but in all probability not their business models or potential to be profitable well run companies. This is also a time to look into “averaging down”.  By buying shares at a lower cost than the original one, the book value (cost) per share held in the portfolio can be substantially reduced.  This means it will take a smaller upward movement of the share to recoup any losses currently being made and move back into positive territory.
 
Ask anyone who has been investing for the last 10 years.  In all probability they are not among the people panicking as they have seen these cycles come and go. According to them buying in the pre-2003 period was well worth the enormous returns they got to make even if it took a while. Even though the NSE has generally been on an upward trend from 2002, the last five years have still been characterized by these cycles. It comes as no surprise that people tend to react in the exact same way every time. A breed of analysts called “technical analysts” are literally paid to basically chart and predict market movements based on this repetitive behaviour.
 
Key is to not get caught up in the crowd mentality. Do not panic with everyone in bad times and not to be greedy with the rest in good times.  This does not mean do not buy or sell in either of these times it just means let your actions be dictated by a plan and a commitment to achieve the objective that put you there in the first place. It is also time to realise speculation or trying to outguess the market is not an investment strategy and regularly fails as an immediate avenue of wealth creation. When you understand why you have invested in the first place, the company you have bought into, its value and what kind of future it holds you can sleep soundly at night, despite short term volatilities.

Waceke Nduati-Omanga is the CEO of Creative Capital Financial Solutions.
[email protected]

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