Saturday, 3 March 2012

Substantial rise in the market: Practical questions and psychological problems confronting the investors

A serious investor is not likely to believe that the day-to-day or even month-to-month fluctuations of the stock market make him richer or poorer.

But what about the longer-term and wider changes in the stock market? Here practical questions present themselves, and the psychological problems are likely to grow complicated.

A substantial rise in the market is 
  • at once a legitimate reason for satisfaction and 
  • a cause for prudent concern, 
  • but it may also bring a strong temptation toward imprudent action.

Your shares have advanced, good!  You are richer than you were, good!
  • But has the price risen too high, and should you think of selling? 
  • Or should you kick yourself for not having bought more shares when the level was lower? 
  • Or— worst thought of all—should you now give way to the bull-market atmosphere, become infected with the enthusiasm, the overconfidence and the greed of the great public (of which, after all, you are a part), and make larger and dangerous commitments
Presented thus in print, the answer to the last question is a self-evident no, but even the intelligent investor is likely to need considerable will power to keep from following the crowd.

It is for these reasons of human nature, even more than by calculation of financial gain or loss, that we favor some kind of mechanical method for varying the proportion of bonds to stocks in the investor’s portfolio.
  • The chief advantage, perhaps, is that such a formula will give him something to do. 
  • As the market advances he will from time to time make sales out of his stockholdings, putting the proceeds into bonds; as it declines he will reverse the procedure. 
  • These activities will provide some outlet for his otherwise too-pent-up energies. 
  • If he is the right kind of investor he will take added satisfaction from the thought that his operations are exactly opposite from those of the crowd.*

* For today’s investor, the ideal strategy for pursuing this “formula” is rebalancing.

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