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The Ostrich Meets the Middle Man

By TAN Kee Wee

(MediaCorp 938LIVE’s Money Talks, Thursday, 18 September 2008, 7.50 am and 7.20 pm)

When we fall in love, it’s quite normal to be obsessed with our loved ones. We will spend hours searching for more information about our new-found love, and we will discuss endlessly the finer points of our loved one with friends.

Investors are no different. When stock markets are up, investors will search for more information about their new-found wealth. They will discuss the merits of the stock endlessly with their friends. And they will seek out information to support their beliefs that a certain price target will be achieved.

This is to be expected. Studies in psychology have found that people unconsciously seek out information that reinforces their own beliefs. This is the “selective exposure” hypothesis.

For instance, new car owners will pay more attention to the advertisements of the cars they have bought, rather than those they did not buy. Likewise, smokers will pay more attention to articles that support smoking, and ignore articles that demonstrate the health hazards of smoking.

But what is the reaction of investors when their stocks do not go up as expected? Likewise, what happens when the loved one we marry turns out to be the wrong choice, and we find ourselves trapped in a failed marriage?

The evidence tells us that even though couples in a failed marriage may continue to live in the same house, both will completely ignore the other. They will live separate lives. Investors are no different. When their stocks are down, they also ignore them.

This reaction has been supported in studies conducted by behavioral economist George Lowenstein of the Carnegie Mellon University. He found that in a bull market, investors check their portfolios frequently. But in a bear market, investors looked at their portfolios about 50% to 80% less often.

Of course, when stock prices first come down, investors will seek out information to explain the losses. But up to a point. Beyond that point, they will ignore additional bad news and lose interest in their investment portfolios altogether.

Lowenstein calls this the “ostrich effect”. It describes the self-denial behaviour of investors, which is sticking their heads in the sand, when their investment portfolios turn bad.

The explanation is that investors do not want to know that they have lost money by checking the latest prices. It is certainly less painful than to know exactly how much they have lost. This way, investors can always retain the hope that their investment portfolios somehow did better.

This “ostrich effect” stems from the observation that almost all investors are emotional about their investments. When they do eventually look at their portfolios, it would be when they are forced to, like when they need the money, or when there’s a margin call.

But by then, it would be too late. The losses would be substantial. To avoid this disaster from happening to you, perhaps the best solution is to put your money in reputable unit trusts or with investment managers.

Granted, these investment managers take too much in commissions and upfront charges. But at least they will look at your portfolios regularly. As the middle man, they are less emotional about investments and they will switch to other assets when you are most unlikely to.

If you are one of those who rushed into, or were encouraged to rush into unit trusts investing in China early this year, your losses should be around 50%.

But if you had picked your own stocks, the chances are that you will keep holding on to your losing stocks. Like the mythical ostrich burying its head in the sand, you will ignore all bad news this year. In the end, your losses would probably be closer to 80%.

This ostrich behaviour of most investors suggests that the services of an investment manager are a necessary evil. At least, investors have a middle man who manages and gives them regular news updates about their portfolios.

The spouses in a failed marriage cannot enjoy the services of such a middle man. They have no choice but to depend on their children for regular news updates about the other spouse. In the absence of children, it has to be the family dog.

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