Human Psychology # Asset Price # Risk

Last week was an interesting one, considering that I interacted with a couple of people and most of them were unhappy about their Mutual Fund portfolio performance over the last 12 months, and were feeling anxious about their fund manager, their choice of funds, overall future market potential return, some of them also concluding that equities never make money, thereby wanting to redeem their funds.

While yes, obviously, in the short run, equity investments may not make money and for sure, it is not for the faint-hearted. Warren Buffett had warned people to stay away from the equity markets by stating the following:

“Unless you can watch your stock-holding decline by 50% without becoming panic-stricken, you should not be in the stock market”

While, if the oscillation of stock prices (obviously when their holdings are going down in prices) is considered risky by these participants, it’s obviously flawed; easier to write, but harder to keep calm.

While fundamentals of the asset play an important part in determining its price, but Human psychology plays an equally important role in determining the asset’s price, at times, higher!!

Incessant perceived +ve Optimism by a group of participants results in Asset Price to move up. As the asset price moves up, new participants bid up the asset price, since there is a fear of missing out (‘FOMO’), because of greed. With greed, risk tolerance and credulousness of the existing and new participants’ increases. As the asset price increases, potential return for the participants declines, thereby resulting in increased riskiness for them. There comes a tipping point, where increased riskiness results in the asset price to fall.

With the asset price falling due to increased pessimism, fear of participants increases manifold. Increased fearfulness results in increased risk aversion, wherein the participants start dumping their assets, resulting in risk aversion. The increased risk aversion for the participants results in increased scepticism. As the asset price declines, their prospective returns increase, resulting in declinature of risk. There comes a tipping point once again wherein enhanced scepticism pushes the asset price so low that the risk declines.

Increase optimism results in enhanced prices, however with enhanced price comes higher risk; on the other hand, increased pessimism results in asset price declinature, thereby lowering the risk. Obviously, in both the scenarios, the assumption is that the asset’s inherent intrinsic value is unaltered.

Disclaimer: Please note that these are my personal views. While, I am a registered Research Analyst as per SEBI (Research Analyst) Regulations, 2014, all investors are advised to conduct their own independent research into individual stocks or industries before making any decision. In addition, investors are advised that past stock performance is not indicative of future price action.

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