Stock markets can be a reflection of public opinion and feeling, rather than of actual performance.
Don’t let your feelings interfere with logic when building your financial planning strategy.
The stock Credit: Image: jscreationzs / FreeDigitalPhotos.netmarket doesn’t represent the current economic situation in the world. Rather, it shows what people think will happen in the future. If “the market” (all the people who are buying and selling stocks) believes that the world of money will improve, individuals will start buying stocks. The opposite is also true; if they feel that healthcare reform, war, and unemployment loom forebodingly, they’ll sell. If there are more buyers than sellers, the stock market will rise; if more people cash out their stocks, the prices will fall. This is because people normally make decisions based on how they feel, not on logic. As such, you can attribute the swings in the stock market to feelings rather than numbers.
There are two active steps to take as a result of having this knowledge. The first is to understand that your own portfolio’s movements may not accurately reflect the overall economy, and the second is to realize how you yourself make investment decisions.
If the underlying financials of a company aren’t represented by its share prices, consider what “the market” believes (regardless of whether facts support this). For example, if the market believes that the price of oil will jump, you might want to consider investing in drilling companies. Even if we can’t predict the price of oil, if enough people believe it will go up, then they will buy stocks that could profit from its move, and you may profit from purchasing shares in a drilling company.
As for investor psychology, be wary about letting your emotions get the better of you when making investment decisions. A client I met recently said that she knew she should have a percentage of her portfolio in stocks, but couldn’t bear to lose money and even large-cap stocks were too risky for her. Therefore, I bought her only CDs (certificates of deposits in banks, which are insured by the FDIC).
When handling your own money, think about what Vincent Van Gogh said: Let's not forget that the little emotions are the great captains of our lives and we obey them without realizing it.
Disclaimer: This article is for educational purposes and is not a substitute for investment advice that takes into account each individual’s special position and needs. Past performance is no guarantee of future returns.