Good investment habits versus damaging biases
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.
Written by Robin Bowerman
Head of Corporate Affairs at Vanguard.
25 June 2019