Emotions in Investment

Investing is a very difficult game especially when human emotion is involved. Everyone has cognitive biases. It is defined as a systematic error in thinking which affects decision making. In order to maximize our wealth accumulation over the entire life and generations, we need to understand our emotion system and manage it.

The book “Behavioral Finance and Wealth Management” by Michael M. Pompian details the common human investor types.

1. Type: Preserver

He is the passive investor, value financial security and wealth preservation compared to growth. He is high risk averse and taking losses will be extremely painful.

Bias: Loss aversion

He experiences lesser satisfaction towards gains and even a greater dissatisfaction towards losses, even if gains and losses are equivalent. People tend to sell their winners and hold on to their losers, hoping to recoup the investment over time, even though this may lead to more losses.

Strategy: Slow and Steady

He should not invest aggressively regardless of age and time horizon because he may not adhere to his investment plan. He should use less risky, slower growth investment tool and higher savings to achieve his financial goal.

2. Type: Follower

He is the passive investor type, taking advice from friends, family and colleagues.

Bias: Regret

He fears regret and feels threaten when he may make a wrong decision.

Strategy: Stay the course

He should always question whether the advice fits into his long term financial plan and goals. He should not make abrupt financial decision which may increase the risk and returns.

3. Type: Independent

He is the active investor, act swiftly and confident in his own research. He conducts a lot of research and gathers information when it comes to decision making.

Bias: Conservatism

Overconfident in his own research, major decisions based on a positive or negative outlook can jeopardize long term goals. He may hesitate to take action based on new information and instead rely on initial information. He may be inflexible to react accordingly.

Strategy: Follow the market

He is analytical. He should work with an adviser which can provide metrics and discuss information with him. Invest in long term growth of the market and avoid timing it.

4. Accumulator

He is active investor with strong risk appetite. He believes that he can be successful in investing.

Bias: Overconfidence

He has a false sense of control and take on too much risks in investments. He will have difficulty sticking to the long term strategy and will change according to the market direction. By timing the market, he will incur more trading costs and lower performance in the long run.

Strategy: Look for blind spots.

Seek data which contradicts to his findings to have a balanced analysis before making important decisions.

After understanding this, I learn that I am a Preserver. I am a dividend income investor and dislike taking losses. Earlier in the day, I cut loss on Thai Beverage and switch to OCBC as I found a window for this move. I sold 67,000 shares of Thai Beverage and switch to 4,000 shares of OCBC. This move realized a permanent capital loss of approximately S$14k. This is very painful for me.

I will continue to invest and build up the retirement fund. There are a lot of fine tuning in my investment style.

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