This article was originally published in Money Magazine, on October 8, 2022.
We all like to think we make investment decisions based on hard facts. But psychology impacts all of us – especially when it comes to money matters.
As an investor, it’s important to acknowledge that you’ll feel a range of emotions – some good, some not so good.
What matters is that you don’t allow those emotions to get the better of you, or form the basis of investment decisions.
That’s not always easy because as humans we have unconscious biases – attitudes or beliefs we may not even be aware of, which can shape the way we invest.
Let’s take a look at a few well-known biases, and why they could cost you.
1. Our desire to follow the herd
As humans, our instinct is to follow the herd. This can especially be the case when it comes to investing.
Here’s an example. On March 16, 2020, at the start of the COVID pandemic, the ASX 200 fell by 9.7% – the largest one-day fall in over 30 years. It absolutely spooked investors, many of whom rushed to sell their shares. The panic selling meant that by March 23, the ASX 200 was 35% below its February 20 pea.
Yet over the nine months that followed, the ASX 200 soared by a massive 47%. Those investors who followed the herd not only cemented losses on shares that later recovered their value, they were also more likely to pay more to get back into the market at a later stage.
2. Loss aversion
For some of us, the fear of losing money outweighs the excitement of making money. This fear can see people avoid investing altogether – and it probably goes a long way to explaining why Australians have about $1.5 trillion sitting in cash deposits earning next-to-nothing in interest.
3. Familiarity bias
Most of us know it’s a sensible strategy to spread our money over a variety of investments. But we tend to stick with what’s familiar.
You may be familiar with Aussie shares for instance, so that’s where you focus your shareholdings. The risk is that your portfolio relies entirely on the strength of the Australian economy. By investing in shares in other parts of the world, such as US stocks like Apple or Amazon, you can reduce the impact of any shocks to the local economy on your investment portfolio.
How can I stop emotions ruling my investment choices?
There are many other subconscious biases that can impact our decisions. But there is a simple way to keep biases and emotions out of investing.
There’s a great quote on this from Warren Buffett, a man often viewed as one of the world’s most successful investors.
He says that to invest successfully you don’t need to be a genius. You just need “a sound framework for making decisions and the ability to keep emotions from corroding that framework.”
The framework Buffett is talking about is simple. It’s the investment strategy we should all have in place before starting to invest. Think of it as your money roadmap that sets out how much you can afford to invest, your investment goals, how you feel about risk and your timeframe for investing.
If you have this blueprint to follow it’s a lot easier to overcome your emotions – and stick to your plans even if markets are working against you. That matters because emotionally-charged decisions could hurt you in the long run.
It’s not about tuning out
I often come across commentators who suggest that as long term investors we should avoid ‘market noise’. The idea is that we should turn off the TV or radio when the news is bad in order to avoid letting our emotions take over.
But it’s not that simple.
We live in a 24/7 news cycle. And even if it was possible to tune out, something as simple as a conversation with a work colleague, who has differing views from your own, could trigger anxiety about your investments.
That’s why it’s so important to have that initial framework in place. It helps you make the right decisions for your investment strategy and keep a cool head no matter what investment markets are doing.
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