Looking for Freud on Dalal Street
Namita Devidayal learns that psychology has a lot to do with why stock prices go up and bank balances go down What is Freud doing lurking around in the stock markets? You'd be surprised! According to those who have studied behavioural sciences, there are strong links between psychology and money habits. A knowledge of human behaviour can vastly improve our chances of making money and understanding why, and how, people spend or save. For instance, people's tendency to over-react is probably the most popularly known effect of human behaviour on stock prices. And who would imagine that experiences which took place during one's adolescence can have a deep impact on the way people invest? That is why financial planner Gaurav Mashruwala asks his clients to reveal their first memories about money. "Your childhood and teenage experiences have a massive impact on your approach to money," says Mashruwala. He describes the case of a client who came to him for advice. He found that she was not at all worried about money or saving for her retirement. He probed deeper and found that when she was 17, her father died suddenly, leaving the family in debt. She was a month away from leaving for higher studies in Australia. But she studied, earned very well and was able to take care of her family. "So she has this capacity of rising from nothing. She knew that she could make money any time. She was not worried," he explains. Here are some common traits in the psychology of finance. Two ends of a ruler: According to Mashruwala, a keen student of financial psychology, there are three basic associations one has with money: earning, spending, and management, and all these can be traced back to early family experiences. The way to look at people's approach to any of these is, assume there is a ruler. Extreme behaviour patterns fall on either end of the ruler, while normal patterns are in the centre. So, in the case of earning, at one end of the ruler will be people who will commit a crime to earn. At the other end will be someone who is not bothered about earning. The person who wants to earn a healthy living will fall somewhere in between. When it comes to spending, one end of the ruler has people who are miserly. At the other end are those who will blithely borrow to spend. Those in the middle like to spend, but within their means. Finally, in the case of money management, one end features those who can't find their cheque books when they need them, and the other end has those who make notes of every paisa spent. Rear-view driving: When you are driving ahead, you should look through the windshield in front of you rather than constantly at the rear-view mirror. For, if you keep looking at past events to make your decisions, you are likely to have an accident. For instance, if you buy stock that has risen to Rs 200, and then fallen to Rs 70, you are the kind of person who bases your investment decisions on the past price, rather than future potential. This is a common pattern seen during bull runs such as the one we are currently experiencing. Just because stocks have been rising over the past year does not mean the trend will continue unconditionally. Anchoring: This is a pattern where your mind is anchored only to the last memory or event, and conveniently forgets older events. It is a common trait that figures in stock market investments. Here's how. Assume a share is being quoted at Rs 27, but you are not willing to buy it at that price. The share price climbs to Rs 100, and then falls to Rs 70. Suddenly, you want to buy that share—perhaps because it has become 'hot'. You forget that you didn't buy it when it was much lower. Your mind is anchored only to the fact that it has fallen from Rs 100. Contrarian versus herd mentality: Rather than being a contrarian, who picks stocks that are out of favour with the vast majority, do you opt to follow the herd? This kind of behaviour usually leads to momentum investing, where every thing goes up regardless of its inherent value. Remember the weird tech stocks that ran up during the technology boom? Prospect theory: This is the tendency of people to react to gains and losses in a dramatically different manner. If you get a 10% profit, you are only mildly satisfied, but if you experience a 10% loss you would react very adversely. Our money shrink Mashruwala suggests that this pattern could be due to a very serious loss of money in the past which affects the individual every time he loses. Loss has more pain, gain does not give as much satisfaction. This may be because you have lost a lot of money in the past and that is why this would have a very big impact on you every time you lose. Now lie on a couch, regress, and figure out whether you are going to get rich or remain forever stuck in that tubelit cubicle with a Shrek-like boss.
