By Mary Holm, independent financial writer. Article reprinted from Holm Truths* with permission from Mary Holm.
Feelings affect most things you do. And quite right too! But should you let them affect your investment decisions?
To some extent yes. It’s important to feel comfortable about your savings. And, if you have a positive attitude, you’re likely to save more.
But a growing body of research shows that emotion, prejudices, limited vision and other psychological factors affect investing in ways you may not be aware of. This can lead to decisions that hurt your chances of getting the best risk-adjusted returns you can.
It’s helpful – as well as fascinating – to be aware of what’s going on. You may then modify your behaviour or at least make allowances for it.
Some common investor foibles
About 80% of people think they are above average at driving, and investing may be similar. People tend to remember their good investments and give themselves credit for them. The poor investments were bad luck, best forgotten!
Over-confidence can lead to too little diversification. If you’ve picked good investments, why hedge your bets? Because your selections might, in fact, not be so hot.
Also when inexperienced investors start an investment, they often don’t appreciate that they will sometimes do badly. Currently this is not so true of share investors, because of the terrible recent performance in world shares. But it may well be true of recent property investors. In time, that will reverse. Both markets will have their down periods.
Fear of regret
Many investors don’t want to sell unless they can get more than the purchase price – and sometimes end up sticking with a “dog” for years. Even professional managers tend to hold on to their losers for too long and sell their winners too quickly. I’m not saying you should bail out of well-chosen investments just because they have bad years. But if you realise that an investment is wrong for you, get out of it. It’s irrelevant what you paid for it.
Following the crowd
You may feel it’s not so bad to make a loss if everyone else does. It may be less embarrassing, but there’s no logic to that. You’re more likely to do well if you buy when others are selling and sell when others are buying. Or in many cases, just buy and hold.
Sticking with the status quo
If you were starting now, would you have your current portfolio? If not, why have you got it? Many people spend more time deciding which clothes to buy than which investments to make. Put a bit of time into your investments now and you’ll be able to buy many more clothes later!
People often keep investments they have inherited or been given. This is partly a status quo issue. But you might also feel disloyal if you sell. If the investment is unsuitable for you, wouldn’t the giver prefer you to do something else with the money?
Having lots of information makes some investors over-confident. But others are overwhelmed. After doing research, they can’t decide which move to make and so do nothing. If you’ve narrowed your options down to two or three, perhaps you should just allocate your money among them rather than agonising over which might be best.
People put too much weight on the recent past. After a bad market, they overestimate the chances of another bad year. The reverse is true after a good market. Economist Richard Thaler once suggested investors should be banned from reviewing their progress more than once every five years. But many investors receive quarterly statements and some check their progress daily. Put more weight on how you’ve done over the last five or ten years than over the last three months.
It’s often useful to see patterns in data. Sometimes though, people see patterns that are there by mere coincidence. Around the time of the 1929 Wall Street Crash, for example, observers noted a close correlation between New York and London share prices and levels of solar radiation.
People respond to how things are framed. They don’t like an investment that has losses one year in ten, as much as one that gains nine years in ten. Given a choice of a share fund and a bond fund in a super scheme, investors tend to put half their money in each. Given a choice of a fund of big NZ shares, a find of small NZ shares, a world share and a bond fund, they will tend to put a quarter in each, ending up with much more in shares.
Most people like to have their pre-judgments confirmed. If, instead, you challenged your thinking, you would learn more.
Can’t see the forest…
Investors tend to look at the performance of the individual parts of their portfolio instead of whole thing. If you’ve diversified to average out the movements of difference investments, let that work for you.
* Holm Truths is an independent quarterly newsletter distributed by companies to their employees, superannuation scheme members, clients and the like.
The views or information given in this article are not necessarily the views of AMP or AMP Adviser Businesses. It provides general financial information and is not intended to provide financial advice. For personalised financial advice, we recommend you contact us.