Psychology of investment

One of the least discussed, in terms of tweets and SM platform which are flooded with recommendations and analysis of various investments, is the psychology of investment. No doubt there are various popular books that discuss these, but less talked about in Social medias.

Why is this important in our investment journey. Humans generally tend to be conservative. If they bought 10 apples, they will eat 1 or 2 and then keep it for next few days. This practice arises from the fear that they may not be able to get it later and thus enjoy over a period of time. Some economists also call this Marginal Utility.

Coming back to the psychology of investment, Investors generally tend to see what is Value At Risk. This means how much am I able to bear to lose in a worst case scenario. This acts as a security chain which prevents moving freely. 

Imagine  you are on top of huge cliff and there is a river flowing below. Would you dare jump. Some do and do it without fear, while others hesitate. This principle also follows in the investment world. A person with 50,000 Rs balance may take a giant leap and invest 49,000 Rs, while a person with 10 lakhs may consider investing 10,000 Rs. When the market jumps 100%, the 49,000 makes a total of 98,000 Rs (including investment), while the other guy makes 20,000 Rs (including investment). Thus for 1st guy VAR is 49,000, while for 2nd guy VAR is 10,000.

As I mentioned in my earlier post position (no of shares) as well as VAR are two critical factors in making money in the investment world and how good you are at it is the key.

To do the above, conviction on the shares you buy (which includes a lot of research) has to be there. It is always possible that you could also lose heavily like if market had crashed, the 1st guy will lose 49,000, while 2nd one will lose only 10,000.

One of the steps to mitigate the VAR is to build a portfolio over a period of 10-15 years. It is possible some of the items in the portfolio will be duds, but overall it will give you a good return.

Thus if you jump into the investment world, a certain risk has to be taken. Otherwise do not invest. If you expect to get 15-20% return without risk when the risk free return in govt. bonds/FD's is 6-7%, then you may as well forget about investment.

Having said above, it is also critical to save in safe investments that will at least allow you to pay rent and food, but may not get you high returns. While you save from salary building your positions, bonuses or any windfalls are key to invest more or hold cash without spending for the market to fall and take advantage.

This brings another aspect of Psychology. Holding Cash. This is a critical element in investment. When the going is really great that is some of your portfolio elements have you given you 50+% gains, you may want to cash part of it. What do you do with the cash you got. This is where smart people hold the cash. There is always the urge when you have large cash on hand to spend or invest ( without fear ) invariably without doing a research. This is where lot of people lose money and when the right opportunity comes, they find themselves without cash. Thus Holding Cash for long ( put in liquid funds or FD with a low return - 2-3%) is also a psychological factor for good investment.

Imagine someone had sufficient cash just before covid and when the market crashed or the 2008 financial crises when market crashed and bought some well known companies at a low price and keeping VAR and position in mind, he/she would be a big millionaire by now.

Thus psychology plays a big role in the way you invest apart from the fundamental/technical research that one does.

Some people invest when market crashes in a long and steady dividend paying company. This ensures a good yield of 7-8% and helps in keeping a regular income to pay for rent and food, while other funds can explore VAR.