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How Investor Mindset Moves The Markets

If they’re armed with all the research available in today’s information age, why can’t economists agree on where are our property markets are heading?

In fact, a better question would be – why do so many get it wrong?

The simple answer is that market movements are far from an exact science. The fundamentals are easy to monitor. Things like population growth, supply and demand, employment levels, interest rates, affordability and inflationary pressures.

However, one overriding factor that the experts have difficulty quantifying is investor sentiment. And that’s what’s really been behind market movements of late.

I’ve found that investors often suffer lapses of logic when investing and many of their investment decisions are driven by emotion. For example, we tend to extrapolate the present in the future. When things are booming, we tend to think the good times will never end and when the market mood is glum, we have difficulty seeing the light at the end of the tunnel.

Think about it…when the media is full of reports about property prices falling and an impending housing crash, many investors become scared and sit on the sidelines, believing the end of property is nigh and things will never improve, when in reality much of the risk has been removed form the market.

Conversely, when property markets are booming and stories of investors seemingly making large gains overnight abound, people want to jump on the bandwagon and cash in, often at a time when the market is near its peak.

Other emotional traps include becoming overconfident, wishful thinking and ignoring information that conflicts with your current views. In other words, many investors make their own “reality.”

Can you see how investor psychology, drives booms and busts? Can you see how the dominant investor mentality of the time helps drive the property cycle?

Just to make things clear…home buyers, who make up a round 70% of property transactions drive our property markets. But investor activity creates our booms and busts.

Simply, a few years ago investor frenzy driven by Fear Of Missing Out drove the property markets in Sydney and Melbourne to dizzy heights. Now that investors have put on the brake’s property values are falling. But in due course, they’ll jump back into the market, demand will rise and so will prices.

Obviously one or two misguided investors won’t be able to influence property prices, but investor psychology is infectious.

People tend to want to do what others are doing - they ‘follow the herd’ because going against popular opinion is perceived as risky. What if you make a mistake? What if “the crowd” is right and you are wrong?

This behaviour stems back to the days of our ancestors when it was safer to remain part of the herd rather than leave the security of the pack and be eaten by a sabre-toothed Tiger.

This “herd behaviour” is magnified by several things including;

• Mass communication and social media bombarding us with messages and facilitating behaviour to become infectious. When we hear that real estate is doomed, all but a handful of sophisticated investors get scared out of the game. And when the media tells us our property markets are booming, everyone wants a piece of the action.

• Pressure to conform. If your friends or family are doing it, it must be right. Right? Human nature makes us reluctant to do the opposite of what our peers are doing.

• A general belief that grows and spreads. Every cycle there is a new generation of uneducated investors who have not experienced the cyclical nature of our property markets and they are (mis)led to believe that property values can only go one way, and fuelled by property marketers and spruikers they enter the market pushing up prices, perpetuating the belief and helping make it a reality! Similarly, when the herd believes the market is going to crash, they steer clear, this gets reported in the media and the negative sentiment feeds on itself.

These “lapses in logic” by individual investors and the magnification of such lapses by crowd psychology feeds property cycles and goes a long way in explaining why we’re experiencing the current property slump, despite the strong underlying fundamentals.

When investor sentiment is positive, the crowd jumps in feet first, pushes up demand and places upward pressure on prices – causing boom conditions. Conversely when sentiment is negative, the crowd backs off and frequently sells out of the game due to concerns that they’re about to lose everything – causing slumps or bust conditions in the marketplace.

The best defence is to be aware of past market cycles (so nothing comes as a surprise) and to avoid being sucked into booms and spat out during busts.

Of course, for those with a long term perspective, and that’s the only way to invest, buying property today when others are fearful is a smart strategy.

I’ve always been an advocate of counter-cyclical investing. This approach is commonly taken by savvy investors who have come to understand that moving against the crowd often produces the best results and can mean the difference between outstanding gains in the property market and average ones.

Sure, it takes some courage to do the opposite of what everyone else is doing, but the results of your contrary behaviour will ultimately speak for themselves.

Source: Your Investment Property 2nd July 2019

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