(Paraphrased by Financial Times article “Psychological traps investors should be wary of”)
Humans are wired to act upon instinct when it comes to protecting themselves and we jump into defensive mode when faced with a crisis. As marvellous as this trait has served us in our existence, it is our own worst enemy when it comes to managing our money and our long-term investments.
COVID-19 has proved to be an example of a “crisis” that has seen the world jump into defensive action worldwide. Beyond the human crisis at hand, our economies have been rattled and sent the financial markets riding a rollercoaster of volatility, leaving investors facing psychological battles in these tumultuous times. Unfortunately, times like this can lead to detrimental decisions being made on your portfolios and may end up costing you significantly in the long run due.
Psychology is a hugely important factor when it comes to investing. A natural response to seeing your portfolio drop in value is to sell the asset to protect yourself from further losses. Most people feel an immediate sense of relief by doing so — really, you are probably doing more harm than good, especially for your overall long-term gains. Storms will pass! History has shown again and again that markets recover, which is a must to remember for long-term investors.
“When the market is crashing, investors behave like it’s always going to go down” (Sam Lamas, Morningstar).
Research has evidenced that investors who are active in their trading generally come off worse than those who trade infrequently, or not at all. The bulk of these losses are made when cashing out in a decline, re-entering at an inopportune time and missing out on the subsequent recovery that markets do time and time again. What have we been saying for years? Do not try and time the market! Storms will pass.
Our brain is a magnificent organ that helps us make sensible decisions to protect us, keeping us alive and functioning. Unfortunately, this marvel doesn’t so naturally aid us when it comes to managing our money; instead, it proves bias to seeing trends that won’t affect our long-term goals and prompts us to act largely upon a “feeling” as a form of defence. Market history, fundamentals and age-old advice are thrown out of the window by our brain’s flight mechanism in a downturn.
“Investors follow the same behaviour again and again in market sell-offs. They need some kind of emotional circuit breaker.” (James Norton, Vanguard UK).
On the other end of the scale, investors overestimate their abilities and over-rely on their intuition, suffering from “overconfidence bias” (Steve Wendel, Morningstar).
Investing can easily make you uneasy as, generally, the best decisions go against our defensive, instinctive nature as human beings. For medium to long-term investing, focusing on and making decisions in the short-term does no favour to your future gains. This fixation is called “myopic loss behaviour”. Most impulsive decisions are made when worrying too much on the daily or weekly — even monthly — swings in the short term.
“The right thing for your long-term goals is always emotionally uncomfortable for the present self. This gets greatly exacerbated during times of crisis. We don’t feel comfortable doing nothing, though, often, that is exactly the right thing to do if you’re an investor” (Greg Davies, Oxford Risk)
Doing nothing makes us twitchy; we are impatient beings, especially in 2020, when we want immediate action. 20% of investors say they check their portfolios daily (BMO), which is a terrible habit long-term investors should avoid.
“The more people check their portfolios, the worse the decisions they’ll make” (Steve Wendel)
It is my job to manage investments and I don’t check portfolios daily!
As humans, we want to be in control of situations and make decisions to help us feel this way. Yet, when it comes to the financial markets — especially in a crisis — we are, in fact, powerless.
In such a situation, it is recommended to find a “displacement activity”, something to stop you from making rash decisions that can negatively affect your portfolios.
For example, organising your finances, cutting back on expenditure and setting up budgets are all ways to help you feel more in control of your money during market downturns. COVID-19 has presented an opportunity to sit back and take the time to balance one’s finances and focus on the priorities of our wealth whilst we ride out this storm.
If you still have that “itch” and want to make a trade, take the time to talk it over with someone; whether it be a professional (*cough*) or simply a friend, speaking out loud and another perspective may help rationalise a decision.
I live by the “Rule of 3” across a lot of areas of my life and this proves a useful tool when you find yourself wanting to take action on your portfolio. Sam Lamas agrees that when you feel the urge to make a trade/movement, give yourself three days before you make any transaction. What this does is give the analytical side of your brain the time to ponder the real consequences of your initial, emotionally driven desire.
Another option is to simply write down why you want to make the decision and how it will put you in a better position than you already are. Writing it down can help unscramble your thoughts and organise it more clearly; writing these impulses in the same place can help you see the patterns of your emotional urges and understand whether these decisions are good or not (James Norton).
Leave Your Emotions At The Door
Investors often worry too much about when to enter the market. This is common for those starting out who keep waiting for an opportune time to enter, when more likely than not they should just get going. Those already invested often wait too long to inject any extra cash into their portfolios, or sell out in times when staying put would be best.
This is where making rules for yourself can help stop your emotional behaviour disrupting your portfolio; if you can keep a cool head in a time of crisis, or even in any market downturn, your future gains will thank you.
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Feel like you might struggle? Well, that’s where I come in. As an adviser, I can help take the emotional side away from your investments, partly as it is my job to know to do so, but also because it is another voice of reason to help you feel more in control when things around you may feel like a wave crashing.
So, if you fancy a helping hand, drop me an email at thomas@absolutefsl.com to see how I can help!
