The “hot bath” theory

Private Property South Africa
Real Estate Investment Magazine

What does a nice, hot, deep bath have to do with investing? More than you think! In fact, it could be the most important lesson you’ve learnt since reading Dr Seuss’ The Bike Lesson many years ago, in which Junior Bear learnt one lesson after the other on what NOT to do!

Learning what not to do is as important­ — and sometimes more important — than learning what to do. And so it is with the “hot bath” investor syndrome.

You see, when it comes to investing, the average person acts as if they are about to take a hot, relaxing bath. Most people don’t get into the bath while it is filling up with hot water, they wait until the bath is full before they get in. Soon, the water starts cooling down, but most people will try to top up the bath with hot water, instead of simply getting out while the water is still warm. In fact, many will eventually find themselves in either a cold or an empty bath …

Why do we not get in while the bath is filling up? Or get out before it starts cooling down? This irrational human behaviour reflects the way most people approach the market.

Bath with the smart investors

Most investors do not get in at the start of a new trend, when in fact they should be doing so, like the smart investors do. Instead, they wait for the market to heat up considerably. Only after the market has moved up over a sustained period, and the trend is well-confirmed, do most investors get in. And it feels comfortable in a mature market that seems set to continue moving up, creating a (false) sense of security.

Then the market cools a bit. And most investors tell themselves, “No problem, just a chance to top up a bit”. Then, the market drops sharply and really starts cooling. It’s getting uncomfortable. But most investors don’t get out, wanting to believe that the comfy warmth of a heated market will continue forever. But it doesn’t. By now, these investors are almost numbed at the thought of doing anything. So they don’t. And before long, they are sitting in a cold, empty market that is too uncomfortable to stay in any longer. Finally they get out … just when the market has bottomed and is about to start a new swing up.

Unfortunately, this “hot bath” investor syndrome afflicts the majority of investors: getting in when they should be getting out, and getting out when they should be getting in. And that is why 80 to 90% of investors lose money.

The antidote to “hot bath” investor syndrome:

  • Realise that you will default to this mode of emotional-based behaviour unless you have an objective, informed, educated knowledge and view of the market.

  • Know yourself and recognise when the two villains — fear and greed — raise their heads, so you can take action based on analysis, not emotions.

  • Realise that when everyone is agreed on where a market is going, it is likely to do just the opposite.

As Warren Buffet aptly put it, “Be fearful when others are greedy and greedy when others are fearful”. And perhaps we should add: “ … otherwise, take a bath”.

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