In a low-interest, lower-return, more-volatile investment environment, investors have an even greater incentive to keep wealth-damaging behavioural traits or biases under control.
Individual investors have no control, of course, on the emotions of other investors or the overall state of investment markets. However, you can try to keep your emotions in check when making investment decisions.
And it is under your control to create and stick to an appropriately-diversified portfolio, set achievable long-term goals and have realistic expectations for returns. A disciplined investor guided by a solid financial plan is less likely to allow emotions to get in the way of investment success.
Here are seven of the undesirable traits that behavioural economists generally say investors should avoid:
Many investors have an unjustifiable confidence in their ability to make smart investment decisions. Overconfident investors often believe they can pick future winning investments and somehow beat the market.
This overconfidence typically leads to frequently buying and selling shares in a chase for winners and being overly optimistic about the future performance of chosen investments.
An excessive aversion to loss can make investors unreasonably sensitive to investment losses. Such investors tend to sell their winning investments while holding on to losers that are unlikely to recover.
And loss aversion can lead to investors being unwilling to take appropriate investment risks – potentially lowering long-term returns.
Excessively dwelling on past losses can lead to investors focusing too much on part of their portfolio rather than the portfolio as a whole. This trait, also known as “narrow framing”, can hinder an investor’s efforts to have a properly-diversified, long-term portfolio and make them more sensitive to short-term market movements.
Inertia tends to get in the way of beginning to seriously save, saving more whenever possible and developing a long-term financial plan.
Fear and greed
These are the terrible twins of becoming fearful when markets are falling and becoming greedy when markets are rising. Fear and greed often lead to selling shares after prices have sharply fallen, only to buy after prices have sharply risen.
Comfort in crowd-following
Investors often gain a false sense of security by following the investment crowd. As with fear and greed, this usually results in jumping in and out of the markets at the wrong times.
This involves deciding on a course of action and then looking around for evidence to support that action while blocking out contrary opinions and research.
As part of your efforts to keep damaging traits or biases in check, try to block out investment “noise” – the abundance of often-conflicting and misleading information facing investors.
Make the most of investment compounding to magnify your long-term returns. (Compounding occurs as returns are earned on past returns as well as your original investment.) Recognising the rewards of compounding can help investors to stay focussed on the long term.
And think about ways to beat investment inertia including putting yourself into a form of saving “autopilot” by making higher salary-sacrificed super contributions.
Please contact us on 03 9553 0271 if you seek further assistance on this topic.
By Robin Bowerman, Head of Corporate Affairs at Vanguard
Reproduced with permission of Vanguard Investments Australia Ltd
Vanguard Investments Australia Ltd (ABN 72 072 881 086 / AFS Licence 227263) is the product issuer. We have not taken yours and your clients’ circumstances into account when preparing this material so it may not be applicable to the particular situation you are considering. You should consider your circumstances and our Product Disclosure Statement (PDS) or Prospectus before making any investment decision. You can access our PDS or Prospectus online or by calling us. This material was prepared in good faith and we accept no liability for any errors or omissions. Past performance is not an indication of future performance.
© 2019 Vanguard Investments Australia Ltd. All rights reserved.
Any information provided by the author detailed above is separate and external to our business and our Licensee. Neither our business nor our Licensee takes any responsibility for any action or any service provided by the author.
Any links have been provided with permission for information purposes only and will take you to external websites, which are not connected to our company in any way. Note: Our company does not endorse and is not responsible for the accuracy of the contents/information contained within the linked site(s) accessible from this page.