Investor – Autumn 2019
Bringing you market news and investor insights
Why ‘Keep Calm and Carry On’ should be your investment mantra
Investing can be an emotion-driven game. So, with market volatility likely to continue in 2019, how do you arm yourself with the right knowledge to make sound investment decisions and not let your impulses get the better of you? The key is mastering our instincts and regaining control over our impulses, making the old adage ‘Keep Calm and Carry On’ a good rule of thumb when it comes to investment strategy.
To be a successful investor, it is important to be objective and disciplined when making investment decisions. This means making sure decisions align with your long-term goals. While you would be forgiven if tightening US monetary policy, global trade war escalation, budget conflict between Italy and the European Union, and uncertainty over Brexit prompted you to second guess your investment strategy, making changes off the back of these events can lose you money in the long run.
To better understand and overcome our emotional and behavioural biases, we need to learn to identify when we are about to make a decision based on feelings rather than facts.
The four stages in the cycle of ‘market emotions’ shown below correspond to four common behavioural biases that we see as individuals try to make investment decisions. By analysing these biases, we have identified some tips to help you stay on track with your long-term investment goals.
The ‘thrill’ of the ride
You hear ‘resource boom’, ‘tech boom’, ‘credit boom’ – and you want to take advantage, even if it means abandoning your long-term investment strategy. Sounds familiar? This is called ‘optimism bias’. This ‘glass half full’ approach to investing causes us as emotional beings to overestimate the probability of positive outcomes occurring (i.e. gains) and underestimate negative ones (i.e. losses).
Tip: While our ability to imagine better things around the corner drives us to seek change, it is this same habit that can expose us to unexamined risks, sometimes with disastrous results for our investments. It is important that we don’t overestimate the potential upside of financial phases like a boom and instead, exercise restraint and keep your long-term goals in mind.
Ever chosen the same numbers in Lotto because they won the first time? Or perhaps you switched your investment strategy in the past and it worked for you, so you want to do it again? We make decisions like this because of something known as ‘anchoring bias’. Anchoring, or relying too heavily on a past reference to make decisions, has a powerful impact on the choices we make. It often leads us to act on our first thought, idea, or offer, rather than considering our options more thoroughly and thoughtfully.
Tip: When it comes to anchoring in our investment strategy, be wary of rejecting sound and rational financial decisions, such as accepting occasional negative returns for long-term outperformance, even though it can be uncomfortable. Don’t try and time the market, rather trust the experts to do what they do best.
Meet fear and panic
There have been few events that shook investor confidence as much as the 2007 Global Financial Crisis. In the years that followed, we saw investors afflicted by a phenomenon called ‘loss aversion’, where they were willing to do anything to avoid taking another hit. While it is normal to feel nervous in these situations, as investors, we need to remember that ‘bad’ years and losses are normal. It is also important to remember that our brains are good at tricking us into thinking we are losing more often than we are gaining.
Tip: One way to overcome this is to make sure that we don’t take unnecessary risks to avoid future losses. Keep periods of low or negative performance in perspective and focus instead on your long-term goals. Again, you benefit from a ‘Keep Calm and Carry On’ attitude here. The wisest investors are the ones who spend the time up front to create a sound long-term strategy, and then have the discipline to stick to it, even when they’re tempted to react to the market.
Proceed with caution
Now you’re at the end of the cycle of emotions and you might be feeling rather indifferent and full of caution. You feel as if you’d rather not make any change to the way you’re invested, because you’re worried any revision could only lead to losses. This could be a sign that you’re in the grip of ‘status quo bias’—a reflection of human aversion to change. It’s a natural reaction to want to leave things as they are; where it feels easier to lie low and do little to nothing. It’s like choosing to go with a default investment strategy, when you also have the opportunity to make an active choice based on your retirement goals and income expectations, which in turn could lead to improved outcomes.
Tip: Combatting status quo bias is about focusing on the positives of taking action—set aside thirty minutes once a year to review your investment strategy and lean on the experts to help you take action.
A wise investor is a calm investor
Markets move, and investments will always go in and out of favour. We can be responsive and keep our finger on the pulse without being reactive and riding every wave. Sometimes it’s the decisions you choose not to make that count more.
By taking the time to reflect on why you make the financial decisions that you do, you are better able to master the instincts and biases that could be losing you money.
So, next time you notice yourself wanting to make an impulse decision about your investment strategy, we encourage you to ‘Keep Calm and Carry On’.
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