How to avoid investment behavioural traps
Investment markets can be unpredictable. Just when you get used to enjoying a prolonged period of strong returns, suddenly you can be faced with a wild share market rollercoaster and begin wondering whether you should get off.
Consistently strong investment markets can breed overconfidence, and tempt investors into taking undue risk. At the other end of the spectrum, volatile markets can make people nervous and sell out as panic sets in.
Many people don’t realise that the greatest impact on their investment returns could in fact be their own behaviour.
Here are four behavioural traps investors should be aware of:
- Making decisions during market volatility: When you see markets up one day and down the next, it’s easy to be nervous about investing, and this is when we risk making irrational decisions. It’s important to remember that market volatility is inevitable, but that markets tend to bounce back over the long term. While there may be good reasons to sell, you should also remember that by selling out if you’re nervous, when markets are low, may only crystallise losses. One suggestion is to stay focussed on your long-term goals and try to ignore market “noise”.
- Becoming overconfident in strong markets: Many decisions people make during strong markets will likely come right, because the entire market is rising. This will make many feel smart and more confident about their ability to invest. It’s important to remember that returns from rising markets aren’t an indicator of investment skills. It’s how people behave and how their investments perform during times of market distress that are the sign of a good investor.
- Avoiding herd mentality: It’s a natural human tendency to position ourselves relative to others and to feel the need to “keep up”. However this can lead to financially poor decisions. New investment trends can easily get traction in the media and create conversations amongst friends and family. The dotcom bubble is a perfect example: share prices for many internet companies soared, encouraging investors to pour in money. By early 2000 many realised their investments were unsuccessful, speculative ones. Soon after, markets began to crash and investors suffered. While it’s tempting to want to take part in the latest trend, it’s important to take the time to assess any investment on its own merit, and against your personal goals.
- Being swayed by recent events: We are wired to give undue weight to the most recent events. And this is especially true when investing. With the GFC fresh in the minds of many, in 2010 the common view was that Australian shares could do no wrong and global shares were shunned. But then, in the five years that followed, global shares provided far better returns than Australian shares1. This meant that investors who had sold out of global shares missed the rally. And now that global shares have had several years of strong returns, many investors are interested again, yet the best returns have probably been made. Instead of chasing yesterday’s winners, it’s usually best to remain patient and stick to your personal plan.
We often go to considerable efforts to maintain the belief that we’re in control of situations where we really aren’t.
It’s the same for investments: No one truly knows what lies ahead for markets. We believe the best investors can do is plan for a range of different possible outcomes. If the most likely future paths point towards not achieving your goals, you may need to reset your expectations – revise your goals, or perhaps change your savings plan to make up for the difference between what you will need and what your investments may provide.
And consider speaking with a financial adviser. They can support you through the process of reviewing your savings plan and investment portfolio so that it is in line with your goals.
This article first appeared in the March 2016 ASX Investor Update email newsletter.
1 Unhedged global shares returned 8% pa more than Australian shares, over a five year period from 1/10/10 – 30/09/15. Based on MSCI All Country World Index and ASX/S&P 200 Accumulation Index. Source: NAB Asset Management. Past performance is not a reliable indicator of future performance.
Important information from ASX: Information provided is for educational purposes and does not constitute financial product advice. You should obtain independent advice from an Australian financial services licensee before making any financial decisions. ASX does not give any warranty or representation as to the accuracy, reliability or completeness of the information. Where the information includes articles authored by third parties, the views or opinions expressed in such articles are solely those of the author and do not in any way reflect the views or opinions of ASX Limited ABN 98 008 624 691 and its related bodies corporate (“ASX”). To the extent permitted by law, ASX and its employees, officers and contractors shall not be liable for any loss or damage arising in any way from or in connection with any information provided or omitted or from any one acting or refraining to act in reliance on this information.
Important information from MLC Investment Limited: This information is provided by MLC Investment Limited (ABN 30 002 641 661 AFSL 230705) and MLC Limited (ABN 90 000 000 402 AFSL 230694) (together “MLC” or “We”), at 105–153 Miller Street, North Sydney, NSW 2060, members of the National Australia Bank Limited (ABN 12 004 044 4397, AFSL 230 686) group of companies (“NAB Group”). NAB Asset Management is the asset management business of the NAB Group and provides investment advisory services to MLC. MLC may use the services of NAB Group companies where it makes good business sense to do so and will benefit customers and amounts paid for these services are always negotiated on an arm’s length basis. An investment with MLC does not represent a deposit or liability of the NAB Group. This information may constitute general advice. It has been prepared without taking account of individual objectives, financial situation or needs and because of that you should, before acting on the advice, consider the appropriateness of the advice having regard to your personal objectives, financial situation and needs. We believe that the information contained in this communication is correct and that any estimates, opinions, conclusions or recommendations are reasonably held or made as at the time of compilation. However, no warranty is made as to the accuracy or reliability of this information (which may change without notice). We rely on third parties to provide certain information and are not responsible for its accuracy, nor are we liable for any loss arising from it.