Are you an Irrational Investor?

I recently came across a list of the "50 craziest things you can buy on Amazon" which includes such items as 1500 live ladybugs, a human finger bone, a bacon scented moustache, and also an instructional video on how to dance with cats. I'm sure to nobody's surprise there is some irrational money out there (fyi, the dancing with cats video is only $13.22). Irrational purchases online are one thing but what I am more interested in is irrational behavior in investing which has cost people a lot of money since the beginning of the markets.

Behavioral Finance

Behavioral finance focuses on two main irrational behaviors that most investors exhibit which is loss aversion and herd mentality, the former being the most prominent. As humans we are taught to avoid pain and for many the loss of money can be one of their greatest pains. This creates irrational behavior in investors because the assumption is that the market is always rational when it is far from it.

In its simplest form the market is nothing more than a place where people can buy shares in a company from someone looking to sell them. The price is set at that moment in time that a transaction occurs and there is no formal valuation done in the market to justify the price. As an investor if you are going to avoid the irrational pain that seeing a decline in an asset can cause then you need to remind yourself that the price currently showing in the media has no official bearing on what the asset is really worth or what price it will trade at in the future. This comes with the caveat that you are truly investing and not speculating.

Investing Based on Fundamental Facts

Investing occurs when you have the ability (or your advisor has the ability) to evaluate what the true value is of a company based on fundamental facts. Speculation occurs when you buy an asset on the belief that someone will pay you more for it in the future but there are not any fundamental facts that can help you derive a true value of the asset. Herd mentality is also a portfolio killer because people get investment FOMO (fear of missing out).

The true challenge that investors face is that there are always people out there who are going to brag about their investment successes, especially the speculative ones. Thinking about your neighbor who just told you they were up 50% on their latest crypto currency investment does nothing more than boost their ego and makes you feel like you need to get in now or risk missing out on "the opportunity of a lifetime". Our fear of looking stupid to our peers can lead to incredibly poor investment decisions as we do exactly what we shouldn't which is to buy after the price has risen to its apex and ultimately sell after it has come crushing down to earth.

What's even worse is that this behavior can often lead people to feeling like they have been ripped off and that "the stock market doesn't work". Remember, the stock market is nothing more than a place where people can buy and sell from each other. I assure you that it works, just don't make the mistake of thinking that the market promised to take care of you – it did not.

Speculation

Now some may get the idea that what I am saying implies that I don't agree with speculating in the investment space and that would be a false assumption. However, speculation needs to be treated as it is and understood. For most clients I would not recommend speculating on investments because the fear of loss is too great but for some it can be a way to engage an investor with their portfolio. I would recommend limiting speculation to no more than 10% of your portfolio and with the understanding that you may lose all of your money in this type of investment.

If you don't suffer from the irrational behaviors above, this may be something you can stomach but you must go in with realistic expectations. I might also suggest you not brag to your neighbors if you get a win as they are often followed by a loss.

- Grant White, CIM, CFP

Grant White is a Portfolio Manager/Investment Advisor at Endeavour Wealth Management with Industrial Alliance Securities Inc, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.

This information has been prepared by Grant White who is a Portfolio Manager for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Portfolio Manager can open accounts only in the provinces in which they are registered.