Long-term investment requires patience, resilience, and a focus on long-term goals. And yet we’re all susceptible to outside influences and innate biases that can lead to poor investment choices.
According to a recent report from Barclays, half of UK investors admit to making impulsive decisions, with fear of missing out (FOMO) being responsible for 30% of decisions that UK investors go on to regret.
So, what causes us to make these bad decisions and how can we avoid them?
Keeping emotions out of investment decisions isn’t easy, no matter what the emotion is
The Barclays research found that 50% of Brits have made impulsive decisions and that two-thirds of those went on to regret their choices.
While 30% cited FOMO as the reason for an impulsive bad choice, 31% made poor choices after speaking to friends. Last month we looked at why your children shouldn’t take advice from social media and, interestingly, it was the internet that caused the largest number of rash decisions, with 32% quoting social media as a factor.
While there is a clear link between emotions and decision-making, Barclays research suggests that the emotion itself isn’t the important factor. The study found that 34% of investors had made a poor decision when excited, 21% when impatient, and 16% out of fear.
Emotional biases are a well-known and oft-explored factor when investing. Here are some others you should be on the lookout for:
1. Loss aversion bias
Loss aversion could mean that you put more of your emotional energy into avoiding losses than on achieving gains.
Having suffered an investment downturn, you might find that the sting of the loss leaves you keen to avoid that feeling again. Conversely, a gain might have a positive, but short-lived emotional impact. Other biases might kick in and make the gain seem almost inevitable, allowing you to move on to the next opportunity.
Remembering a loss more strongly than you remember a gain could lead to emotional decision-making and poor choices. You might misconstrue your attitude to risk and damage your investment, possibly by holding onto losing stock or being too conservative in your choices.
2. Overconfidence bias
The feeling that your gains are inevitable while your losses are bad luck – or outside of your control – is linked to self-attribution bias and also to overconfidence.
In investing, overconfidence might be a feeling that you have an edge over the competition, that you know something others don’t and so your choices are sure to see the most advantageous returns.
This is dangerous because it can lead you to take higher levels of risk than is necessary. You’ll also fall into the trap of treating investment as a competition.
Your investment portfolio is linked to your long-term goals and attitude to risk. The success of your investment is measured by achieving your goal while taking as little risk as possible. By placing yourself in competition with other investors, you lose focus on your individual goal.
3. Endowment Bias
It’s a human trait to find comfort in owning something and also to assign greater value to that which we own over that which we don’t. You might find that a stock you have already invested in is losing value but your understanding of its worth could be clouded by ownership.
This endowment bias could mean you hold onto a stock despite it losing value. Not only would this damage the value of your portfolio as a direct result of the loss, but you could also miss out on better opportunities elsewhere.
4. Regret aversion bias
Regret aversion means worrying so much about the regret resulting from a bad decision that you fail to make any decision at all.
While you’ll avoid the regret of a bad decision, you might miss out on good decisions. Ultimately, you could become risk-averse. You might also start trend-chasing, that is, incorrectly deeming following the herd to be less risky than making a regrettable decision for yourself.
Get in touch
HA&W can help you to focus on the long term, keeping you on track to reach your goals through risk management and patience.
Emotions play are large part in all our lives but taking a step back before you make important investment decisions can allow you to view your choices objectively and help you avoid dangerous emotional biases.
If you would like to discuss your long-term investment plans, contact us to find out how our Chartered financial planners could help.
Please note
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.
