It’s also about emotional satisfaction

The emotional satisfaction from equity exposure comes from uncertain gains

Does this describe your investment behaviour? You invest your monthly savings in bank deposits. You occasionally invest in real estate to accelerate the returns on your savings. But you do not invest in equity.

In this article, we offer a psychological reason why you should invest in equity. We also show how you should train yourself to allay the fear of investing in equity.

Emotional currency

Which would you prefer: buying an antique piece at a fixed price or through an auction process? If you are desperate to acquire the item, you may prefer the fixed price.

Otherwise, you are likely to choose auction. Why? You may be able to acquire the item at a lower price. But importantly, winning an auction provides emotional satisfaction that comes from the joy of beating a competing bidder.

It is the same emotion at work when you invest in equity. You can draw a parallel comparing bank deposits and equity with an antique offered at fixed price and through an auction. Bank deposits provide known cash flows (akin to a fixed-price antique), but equity offers uncertain, higher expected returns. Of course, there is downside risk, as with an auction, when you buy an item for higher than the fixed price.

The emotional satisfaction from equity exposure comes from the uncertain upside outcome. Also, the stock you pick can outperform the broad market. Picture this. You buy 1,000 shares of a stock at ₹110/share. How would you feel if the stock trades at ₹135/share a week later? You have a similar experience when your friend unexpectedly gifts you a fully paid vacation to your dream destination. It is the dopamine neurons at work in your brain. Suffice it to understand that unexpected positive surprises excite your brain. You will feel the same excitement when you invest in equity and earn higher returns in quick time. The question is: how should you moderate your fear of investing in equity?

Emotional tricks

It is not so much about investing in equity that you fear; it is the hurt that you might experience when your investment declines in value that you prefer to avoid, referred to as regret aversion.

Suppose you win a lottery and decide to save 10 per cent of the amount and spend the rest. Would you then consider investing in equity? Perhaps so. After all, it is free money. This is the same phenomenon at work when you spend free store coupons on items that you will not otherwise have bought with your own money.

What if you trick your brain into similar behaviour with your equity investments? One way to do so is to mentally distance yourself from your investment capital. How? You could invest 10 per cent of your annual salary hike before you enjoy the higher disposable income. The argument is simple. You have not enjoyed the cash flow from the salary hike yet. So, any subsequent investment loss may not hurt you as much as it would when you cut your current consumption and use the savings to invest in equity.

In short, equity offers emotional satisfaction in addition to higher expected returns.

The writer is founder of Navera Consulting. Send your feedback to portfolioideas@thehindu.co.in

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