Why people don’t invest in stocks

QUESTION: Investing in stocks seems to have gained a lot of ground in the past few years. It is so enticing to hear stories of how people have earned so much from investing in companies, and how sophisticated these people have become. Call me simple-minded but I still cannot get myself to risk my hard-earned money in stocks. I am still not comfortable with the risk. Am I just acting weird? Should I join the bandwagon already or is it too late for me?—asked at “Ask a friend, ask Efren” free service available at www.personalfinance.ph and Facebook

Answer: You are not alone. Majority of retail investors are still time-deposit oriented. Allow me to demonstrate.

Say you drop off a friend at a mall because he or she needs to make a quick purchase. You decide to just drive around the mall instead of parking and paying the fee of P45.

You have already driven twice around the mall and your friend is still not out. So you decide to drive to the parking lot and pay the fee after all. As you are driving down the ramp, you suddenly see your friend stepping out of the mall. There is no way to back up as cars have also lined up behind you. You have no choice but to get the parking ticket and immediately drive out, costing you P45 for nothing.

Do you regret paying the parking fee?

When I tell this story at my training runs, people laugh because they can relate to this funny and, yet, sad story. People will regret paying the P45. It’s like they paid P4,500.

On an absolute basis, P45 does not amount to much. If somebody handed me P45 I would not be doing cartwheels out of joy. But why is there regret over the loss of the same P45? Behavioral economists call this the application of the prospect theory, particularly of loss aversion.

Simply put, losses hurt people more than gains please them. This is why you, like many others, are still afraid of investing in the stocks of exchange-listed companies (because of the potential losses).

Now on to your question of whether you should join the bandwagon. As I have always said, investments are mere tools. They are made for man and not the other way around. Your financial goals will determine what kind of investment vehicles you will need. But let us say your goals do require that you invest in stocks of exchange-listed companies. How then can you persuade yourself to take the “plunge?”

Say I will give you P5,000 on the condition that you take one of two options after. If you take option A, you get another P500. If you choose option B, you get a 50 percent chance of receiving P1,000 and a fifty percent chance of getting nothing. Which option will you take?

In experiments done, and I believe you would do the same, most people chose option A.

Allow me to change the scenario. Let us say I will give you P5,000 on the condition that you take one of two options after. If you take option A, you are guaranteed to lose P500. If you choose option B, you get a fifty percent chance of losing one thousand P1,000 and a fifty percent chance of losing nothing. Which option will you take?

In experiments done, this time people chose option B.

Take a closer look. In each scenario, the expected results of option A are the same as those of option B. The conclusions are that, when it comes to earning, people will go after the guaranteed return. And when it comes to preserving against a possible loss, people would take the chance. People will take different action steps depending on how the challenge is framed.

So if what you need to earn is much higher than what ordinary time deposits can give, tell yourself that you will have a better chance of losing less of your lifestyle in the future by investing in stocks of listed companies than by settling for time deposits.

If you want to learn more about behavioral economics please visit www.personalfinance.ph. If you want to set up your own fi nancial consultancy, join us at our Financial Planner’s Training program for the cities of Mandaluyong, Cebu, Cagayan de Oro, Davao and Baguio. Check our website for details on how you can potentially attend for free.

(Efren Ll. Cruz is a registered financial planner of RFP Philippines, personal finance coach, seasoned investment adviser and bestselling author. Questions about the article may be sent by SMS to 0917-5050709 or e-mailed to [email protected]. To learn more about computing for intrinsic value and value investing strategies, attend the Accredited Financial Analyst (AFA) program on June 20 to July 25. For more details, inquire at [email protected] or text <name><e-mail> <AFA> at 0917-3464126.)