Investors Can Be Their Own Worst Enemies

Given the market climate right now, prudent investment has never been more important. Pride Advice’s Tony Davison discusses the pitfalls you should avoid.

As investment markets become increasingly volatile and unpredictable, it is critical for investors to think carefully, challenge assumptions and ask questions no matter how silly they think they may be.

Consider the current COVID-19 health and economic crisis.

In investment circles, this economic downturn is largely considered a Black Swan event: an inexplicable 1-in-100 year phenomenon. The problem is that these rare Black Swan events are becoming more and more frequent, the last one being the 2008 Global Financial Crisis, just 12 short years ago. Other recent crises include the Tech Wreck (2000) and the Asian Financial Crisis (1997), not to mention the 1987 stock market crash, Black Monday.

To demonstrate how confounding markets can be, the current COVID market challenge resulted in an abrupt selloff of more than 30%, seeing a number of investors exit their investments entirely.

These investors’ actions occurred just in time to see markets rally just as extraordinarily over the past three months to reach within 10% of their starting point this calendar year – and in some cases, exceed their starting point (in the case of the US technology index).

In today’s frenetic, fast-paced world, it’s easy to forget to stop and think before acting. When it comes to investing, opportunities are commonly positioned as unique or timely, requiring immediate action. This explains why some people feel pressure to act first and ask questions later.

At the other end of the scale, there is a tendency to set and forget. Given that superannuation, which represents the average Australian’s largest asset behind their home, needs to be managed for a potential 30 year retirement timeframe, it is understandable for investors to become blasé about the management of their retirement assets.

But investors need to take a considered, measured approach and regularly review their strategy to ensure it continues to meet their needs, circumstances and goals.

Clear, objective thinking, in conjunction with professional strategic advice, can add up to 4.4% per annum, according to research by Russell Investments1.

Common investor biases

Source: Russell Investments, 2019 Value of An Adviser Report

Investors need to be mindful of the various behavioural biases that are part-and-parcel of being human, such as confirmation bias and herd mentality.

Confirmation bias is the tendency for investors to interpret and recall information in a manner that confirms or supports their personal beliefs. For example, someone who believes that the Sydney housing market is overheated will interpret low auction clearance rates as evidence that property prices are about to collapse. Some experts held that same belief in 2016 when they warned of a property bubble. That call, of course, proved to be incorrect.

With the internet and social media, it is easy to surround yourself with like-minded people, publications and sites, but prudent investors read widely, consider the counterarguments and keep an open mind. They stick to a disciplined investment approach and are prepared to walk away, if necessary.

Prudent investors base their decisions on research and evidence, not greed and emotion.

Fear of missing out (FOMO) is not just a social anxiety that young people suffer from. It is a common investment affliction, which explains why many investors pour money into speculative assets like bitcoin, micro caps and, in the 1600s, tulips. Most of these ‘things’ turn out to be rubbish (Bitcoin will be no different).

Tulipmania swept through Holland in the mid-1600s, with the rarest tulip bulbs trading for as much as six times the average person’s annual salary. When the bubble eventually burst, Holland’s economy was ruined and thousands lost their fortune, serving as a warning on the dangers of FOMO and following the herd.

Herding describes when individuals blindly follow the actions of a larger group. This often leads to investors buying an asset at the height of a trend and selling at the bottom.

Other common investment pitfalls to be mindful of include misrepresenting data, which can lead to anchoring decisions on spurious information, and overconfidence based on past success.

As the adage goes, past performance is no indication of future performance.

The bottom-line is that no one is immune from making poor investment decisions, which is why it is crucial  for investors to be informed and measured when considering any investment, and to seek professional, objective advice.

  1. https://russellinvestments.com/-/media/files/au/support/business-solutions/practice-management/value-of-adviser/2019-value-of-an-adviser_adviser-report.pdf