How to No Longer Fear Falling Markets

According to Yahoo Finance, at Monday’s close of 3,291, the Straits Times Index (SGX: ^STI) is now 5% off its 52-week high of 3,465 achieved on 22 May 2013.

Some of the index’s components have seen even bigger declines lately. The telecommunications provider Starhub (SGX: CC3) has seen its share price slide by 15% from its peak of $4.76 achieved in early May. Meanwhile, the retail-mall REIT Capitamall Trust (SGX: C38U) has shed 7% of its value over the past two weeks.

With the STI’s recent decline, it does seem that even the market’s bigger stocks are feeling some pressure lately.

For some, especially newcomers to investing, this might seem scary for all of a sudden, they find that some of their net-worth has disappeared momentarily. The fear then paralyses them and they find themselves unable to invest even if stocks appear cheap to them.

It’s easy to dismiss the notion of ‘paralysing-fear’ and proclaim ourselves to be natural-born bargain hunters. But, things are never so clear-cut in life.

Our Un-empathetic Mind

Behaviour economists have been studying how our thinking affects our financial decision-making negatively. More often than not, we’re ruled by emotions even though all of us would like to think of ourselves as thoughtful and rational people.

What this means is that, as humans, we’re often prone to certain predisposed behavioural biases – i.e, the majority of us would think or act in a certain way that deviates from what is normally considered good judgement.

If you think you know yourself very well, think again.

Try and recall the last time you had an extremely filling dinner (imagine chili crabs, pork ribs, soups and more) and someone you know casually mentions, “Hey, how about a buffet dinner tomorrow evening?” Your likely response would have been a scrunched-up face followed by a retort of “Are you kidding me? I’m so stuffed I don’t want to think about food.”

But, come the next day when it is dinner time and you’re starving, that buffet dinner suddenly seems awfully appealing. This is a simple example of a common behavioural bias, called the empathy gap, at work.

It’s a behavioural bias that describes how we’re basically unable to imagine how we would think or feel when we’re in a different mental state.

How an Un-empathetic Mind Can Harm Your Investing

The dinner example’s just a trivial way to show how the empathy gap can influence our decisions. But, it can also have a big impact on our lives. When we’re consumed with anger, it’s hard to imagine what it was like to not be angry and then we might do silly things we’ll regret later.

Similarly, when the market’s stagnant or moving upwards all the time, we can’t imagine the kind of fear we’ll have when it starts nose-diving. And when the fear hits, we become paralysed.

Sir John Templeton, lauded by Money Magazine in 1999 as “arguably the greatest global stock picker of the century”, recognised the problem of ‘paralysing-fear’. To counteract its effects, he made himself a wish-list of stocks.

The wish-list contained prices of stocks that he thought would make great bargains and he always did those calculations in mundane market conditions when fear would have the least effect on his thinking. When stock markets start collapsing, he would exercise the discipline of using his wish-list to identify bargains.

Foolish Bottom Line

Take a leaf from Sir John’s playbook and start finding stocks you’ll love to own only if they’re at cheaper prices. Create a wish-list of such stocks and then wait.

By doing so, fear gets removed from the equation to a large extent. And, when a future market crash comes around, you might find yourself as the one gleefully snapping up the plentiful bargains lying all around.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chong Ser Jing doesn’t own shares in any companies mentioned.