When it comes to successful investing, it’s important to build the right portfolio. But it’s not just about what we buy. How we behave also has a significant impact.
In this series of five articles, we will look at investor behaviour. Behavioural biases are ingrained in all of us. Their origins probably go back to pre-historic times, so they can be difficult to shake.
Still, if you can understand your own patterns of behaviour, you will be better able to control them and make smarter decisions about your finances.
The need to act when danger looms
Early humans’ very survival was grounded in the acute instincts of fight and flight. When attacked, fear set in and led people to either run or mobilise their best defences. Standing by when danger loomed was rarely an option.
To this day, if there’s a crisis, we take action. However, while we are programmed to fix, mend, improve and meddle, investing is different. This is because when people around you are panicking, the best course of action may well be to sit on your hands and do nothing.
Human nature is such that we tend to feel better when we do something. Although it sounds easy, even lazy or, as some financial professionals would have you believe, negligent, doing nothing is often the hardest thing to do. Imagine stock markets falling all around you (as they did in the first half of 2022) and everyone is selling. It’s natural to want to follow the crowd and join in. Prices may have fallen by double-digit percentages and, naturally, you want to protect what you have left. Your friends have smugly told you that they sold a few days ago for a big loss, but the situation is even worse now.
Under such circumstances, it takes real courage to do nothing.
But fast forward a couple of years. You’ve benefited from the discipline of sticking with the plan. Stock markets have recovered and you are making money again. Meanwhile, your friends took their losses and have nursed their wounds. But have they got back into the market? Probably not. Waiting for markets to fall again, they most likely missed the boat.
Strategies to overcome the fight or flight instinct
When fear invades markets and you’re itching to act, remind yourself of a few timeless pieces of investment wisdom.
- Remember that staying the course is hard and that you’re making a conscious decision to do so.
- Remind yourself of your financial goals and the strategy you have set in place to reach them. A good strategy will have factored in the typical ups and downs of markets.
- Have a process to remove the emotion from investing. Decide how often you are going to review your portfolio. Monthly, or even annually, will do for most investors.
- If your asset allocation – the relative weighting of shares and bonds within your portfolio – has drifted away from its target, rebalance your investments. This will ensure your portfolio continues to offer the risk and reward profile you chose. Many multi-asset funds like our LifeStrategy range will do the work of rebalancing for you.
In the following articles, we will look at more situations where we, as human beings, fall victim to distortions in our thinking. And although we are unlikely to be able to ever fix these biases because they are hard-wired into us, simply understanding that they are there will help you to manage them better. In each article, we will also outline a number of actions you can take to give yourself a greater chance of investment success.
Investment risk information:
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
Past performance is not a reliable indicator of future results.
Other important information:
This article is designed for use by, and is directed only at persons resident in the UK.
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