The deep psychology that drives investing – Business Day

Equity investing is, by its nature, a long-term project — otherwise it’s just speculation. The best way to avoid the need to jump ship when equity markets get jittery is to make sure you are invested in quality companies that let you sleep well at night. These are companies with low debt levels that operate in industries with high barriers to entry, which may even emerge from adverse economic shocks stronger than before as weaker competitors fall away.

Since the start of the pandemic we have seen an unprecedented response from central banks globally, and the use of monetary policy tools to stimulate growth. Though interest rates in developed markets were already low going into the pandemic, there have been further cuts and the notion that interest rates will be “lower-for-longer” is now widely accepted.

These stimulus efforts work in part because they encourage more risk-taking and low interest rates are generally positive for equities for a couple of reasons. First, lower interest rates reduce the discount rate used to value the present value of a company’s future cash flows, thereby increasing the value of the company. Second, a company’s future profits are likely to be higher if consumers have more money to spend due to lower interest rates.

However, we need to be aware that investors who are discouraged by the lower returns offered by safer asset classes due to lower interest rates may be taking excessive risks or even fall prey to fraudulent activities as they try to achieve higher returns in riskier assets. As indicated in the accompanying graph, retail traders have been growing their share of US equity trading volumes continuously since 2019, when the US federal funds rate peaked, and now account for almost as much equity trading volume as the mutual and hedge funds markets combined.

The lure of stronger equity returns against a backdrop of declining interest rates has no doubt been a factor. However, increased retail activity in equity markets has been further compounded by the Covid-19 pandemic as individuals in many countries have received stimulus cheques and have increased savings due to having fewer activities on which to spend money.

Investing in the stock market is not limited to professional investors. There are different levels of …….


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