5 ways to avoid emotional capitulation

I know quite a lot of people are sitting on a huge pile of cash, waiting to be deployed into the stock market when the situation presents itself. I'm always very interested in the psychology of investors and how they intend to cope with the volatility of the market. It's really easy to rationalise and say you will cut loss when the counter goes below a certain level and you will buy in when others are fearful. It's even easier to say that when your cash hoard is very high and you have very little skin in the market.


It reminds me of the difference between a chicken and a pig. When you're served breakfast, a chicken is involved while the pig is committed. A chicken will lay an egg and it won't be any more different before and after giving you the egg. On the other hand, a pig will have much more to lose when it gives you the ham.


Are we also like that? When we have huge pile of cash, we can say a lot of rational stuff and quote a lot of Buffett's sayings. That's because we're involved but not yet committed. When you put in a huge percentage of your networth into the stock market, it might be a different story altogether. Things that you thought you should do suddenly becomes so hard because a huge part of your emotional well being is tied to the money you've put into the market i.e. you have skin in the game now. Welcome to real life, committed pigs!

There's a few ways I can think of to mitigate this risk of emotional capitulation:


1. Research and read up really really in depth into the company you're buying. The level of commitment is directly proportional to the homework you've done into it, and not by the amount of articles you've read that is written by a stock market guru. I personally find that the more you know about the company you've bought in, the higher your confidence in buying an unloved counter. If you just follow others, a little spook will get you running and peeing in your pants.


2.  Invest passively into an ETF. Most of the fears comes from losing your money, and that can come from a company going belly up. Buying into ETF will remove that possibility of individual company going bust because an ETF rejuvenates itself by changing the components. It's like a hydra with the ability to regenerate another head when you cut off one of its many heads. That should provide some confidence in the solvency of the companies you've invested, and hence you can really put in a bigger capital when the going gets tough, instead of cashing out and running away.


3. Diversify your investment. Diversification can come in two forms - firstly diversification in terms of companies and industries, and secondly diversification in terms of timing. Unless you know what you're doing, putting 100% of your money into one or two companies can be a strategy to be a millionaire from a billionaire. It can work tremendously well, but it can fail spectacularly as well. For general folks, it might be better to have at least some semblance of diversification across different companies and different sectors. You can take this further by going into different countries, different assets etc. As for diversification in terms of timing, this is another strategy to enter the markets at different intervals instead of one concentrated timing. The underlying principle is that you can't pick the bottom, so dollar cost averaging will likely make your pickings better. If you're a trading god, then forget what I said here because it doesn't apply to you.


4. Just buy and forget. An ostrich approach will work well if you get into blue chips. Looking at all the gyrations of the price will make you want to act, whereas the correct action is simply to do nothing. So stop staring at the counters in your portfolio and get a life! Come back and see once all the smoke and gunpowder smell dissipates, and you might find a dead body or two, together with a handful of gems.


5. This last strategy is controversial. It's just holding a bigger percentage of cash. I know how useless cash is generating for your passive income, but it serves a purpose. It gives you the options to act on the opportunities that may come and this gives hope. From my experience, those who cut loss and run away from the market are those that are over invested either in one or two companies (lack of diversification) or over invested in terms of total networth. Imagine 80% of your networth is in the stock market and when it crashes, leaving only 40% left, you'll start to panic. Having a buffer of cash will help to stabilise the overall volatility of your portfolio and also allows you to keep on getting in on the good deal that comes in.  I seriously doubt I can invest 100% into the market, even in the deepest depth of the market, because that will make me very jittery. It's like telling a frugal man that he has only 1 week to live and he should spend all his money within that week. What if he somehow out live the week? Thus having some cash left over is going to be more calming on the mind, despite his one week dateline to spend.


So, are you going to remain chicken or are you going to be a pig?