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16.JUN.06

Question?: Why are stock markets so influenced by social factors like politics, etc.? It would seem that the financial markets are based more on perception than facts.

Answer: You’re right. It does seem as if the stock market is influenced by perceptual distortions. In fact this is so prevalent that it has resulted in a body of knowledge known as “Behavioral Finance”, which explores how human irrationality can cause movements in stock prices. {{more}}One good example of this is something referred to as the optimistic bias. This theory says that individuals tend to form optimistic opinions about a share’s price and then find it very difficult to change that. Even if news comes out that tends to conflict with their opinion, they tend to underplay it or pay little attention to it. However, if news comes out which is consistent with their opinion they tend to react strongly to it and become even more optimistic. This irrational optimism is one of the causes of the bull markets during the 1990s where no matter what information came out about the markets it would be interpreted as good news.

On the other hand, the fact that the market reacts to political factors may not be irrational as politics does have an inextricable link to the performance of the economy and hence the stock market. For example, one party’s tax policy may be different from another. Depending on which one is in power, the effect on businesses and the stock market can therefore be markedly different.

Question?: From the advice given in your columns, it seems that the sooner we understand how money works, the easier it is to feel financially secure. What are the most important things I can tell my children (aged 9 and 13) about money to give them a good start?

Answer: These are the most important things to tell your kids:

• Develop a savings ethic

• Always draw up a budget periodically which would guide your expenditure Always keep an emergency fund for unforeseen expenses

• Keep informed about ways and means to invest your funds

• Make sure that you are getting the best rate of return for your money for a given level of risk

• Start saving early and benefit from the power of compounding

• Once you can engender these principles into your kids from an early age it would serve them in good stead in managing money for the rest of their lives.

You are right, the sooner they are aware of these principles the better. It is probably best that all children be required to take at least a rudimentary schooling in the basics of money management. However, in most schools kids who go into the “science stream” are not exposed to this at all. Such courses should probably be mandatory just as Mathematics and English are.

All information contained in this article has been obtained from sources that CMMB believes to be accurate and reliable. All opinions and estimates constitute the Author’s judgment as of the date of the article; however neither its accuracy and completeness nor the opinions based thereon are guaranteed. As such, no warranty, express or implied, as to the accuracy, timeliness or completeness of this article is given or made by CMMB in any form whatsoever.

CMMB and/or it employees or directors may, where applicable, make markets and effect transactions, or have positions in securities or companies mentioned herein. Neither the information nor any opinion expressed, shall be construed to be, or constitute an offer or a solicitation to buy or sell.

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