Emotions that influence our investment decisions – and how to tame them

There is no denying it: for stock market investors, it has been a bracing start to 2016. Here’s how four major share indexes have begun the year…

During times like this, it’s easy for ordinary investors to get caught up in the negative sentiment and change course.

But as we aim to invest on a long-term basis, it is important to stick to a sustainable investment strategy, continue to look for good value investments and put ourselves in the best position to capitalise when markets do well or recover.

Having said that, human nature dictates that there is a behavioural bias in everything we do.

We thought it would be interesting to outline the key emotional drivers we think are influencing ordinary investors’ decisions in a time like this – and some ways that you can master them.

Fear

Fear is probably the most dominant emotion in investing. The fear of losing money can override logic and lead to missing out on good value investment opportunities that could help you to be better positioned for the long term.

The tendency:
Pulling out of a bear market and panic selling are key characteristics of an investor consumed by fear.

How to tame it:
If you have taken the wise step of writing down your investment goals and your strategy to reach them, now is a good time to take another look at your plan and remind yourself of those principles. Providing you have enough time before you need to sell your investments, you could begin to counterintuitively recognise the onset of fear as a buying signal.

Greed

Considered the deadly sin of investing, greed – the opposite of fear – is often the most powerful motivator, and frequently takes hold when markets have been on a good run.

The tendency:
Investors under influence of greed may be attracted to quick and high returns and therefore unable to take a long-term view of their financial wellness and subsequent investments.

How to tame it:
As with overcoming fear, the key is to recognise when greed is becoming a driver and train yourself to head in the opposite direction. The challenge is to follow the maxim of renowned investor Warren Buffett:

“You want to be greedy when others are fearful. You want to be fearful when others are greedy. It’s that simple”.

Overconfidence

Overconfidence stems from overestimating your own ability or expertise, perhaps after some early successes. Overconfident investors tend to believe that they have a natural ability to identify a winning investment.

The tendency:
You may be tempted to put too much focus on one asset class and overlook broader factors influencing your investments, which can result in an unbalanced investment strategy.

How to tame it:
While it is good to grow in confidence up to a point, remember that not even investors with a long-term track record get it right all of the time. Think of hedge fund billionaire John Paulson losing a small fortune buying gold near its peak, or Warren Buffett’s recent losses on his shareholding in Tesco. The key is to approach each new investment with the same humility you did the first.

Herd mentality

In investing, a herd mentality refers to the need to follow the crowd instead of making individual investing decisions. Peer pressure and the influence of a large group of people creates fear of regret or missing out.

The tendency:
Investors adopting a herd mentality tend to make uninspired, “copycat” investment decisions that are unlikely to take advantage of opportunities in markets.

How to tame it:
Take a step back. Which investments are being ignored by the crowd? Some of the best long-term track records belong to those with a contrarian approach – investors who look for assets that are attractively priced for no reason other than being out of favour with the mass market.

Ways to control your emotions as an investor

Your challenge, should you choose to accept it, is to eliminate mistakes caused by emotions that sway investment decisions, and be the level-headed investor who wins out in the end!

Of course, that’s easier said than done. If there was no emotion involved in securing your long-term financial wellness, it would be difficult to maintain your interest in investing.

One way you can do this is to delegate the day-to-day portfolio-building decisions to a professional fund manager. This is one reason behind the popularity of multi-asset funds. These funds invest in a blend of different types assets, rather than just shares, in an attempt to spread risk and offer ready-made diversification to investors.

Some examples of multi-asset funds are the Jupiter Merlin series, Episode Income from M&G Investments, and the Momentum Factor Series Funds. They are designed to look through the short term noise and deliver a return that aligns with the needs of investors over the long run.

 

Article: Natznet Fremicael

 


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