In our last update we discussed Sterling Planners’ investment philosophy of “core and satellite”. While we believe this approach delivers results over time, we must also navigate the constant market news and noise which surrounds us all today. This means we must control our emotions and stick to our game plan, while remaining alert to real opportunities if they arise.
Investing can be an emotion-driven game, especially with market volatility ever present in recent times.
How do you arm yourself with the right knowledge to make sound investment decisions and not let your impulses get the better of you?
The key is mastering our instincts and regaining control over our impulses, making the adage ‘stay calm and carry on’ a good rule of thumb when it comes to investment strategy.
To better understand and overcome our emotional and behavioural biases, we need to learn to identify when we are about to make a decision based on feelings rather than facts.
The four stages in the cycle of ‘market emotions’ shown below correspond to four common behavioural biases that we see when making investment decisions.
- Meet fear and panic
There have been few events that shook investor confidence as much as the 2007 Global Financial Crisis. In the years that followed, we saw investors afflicted by a phenomenon called ‘loss aversion’, where they were willing to do anything to avoid taking another hit. While it is normal to feel nervous in these situations, as investors, we need to remember that ‘bad’ years and losses are normal. It is also important to remember that our brains are good at tricking us into thinking we are losing more often than we are gaining.
- Camp Denial
Ever chosen the same numbers in Lotto because they won the first time? Or perhaps you switched your investment strategy in the past and it worked for you, so you want to do it again? We make decisions like this because of something known as ‘anchoring bias’. Anchoring, or relying too heavily on a past reference to make decisions, has a powerful impact on the choices we make. It often leads us to act on our first thought, idea, or offer, rather than considering our options more thoroughly and thoughtfully.
- Proceed with caution
Now you’re at the end of the cycle of emotions and you might be feeling rather indifferent and full of caution. You feel as if you’d rather not make any change to the way you’re invested, because you’re worried any revision could only lead to losses. This could be a sign that you’re in the grip of ‘status quo bias’—a reflection of human aversion to change. It’s a natural reaction to want to leave things as they are; where it feels easier to lie low and do little to nothing. It’s like choosing to go with a default investment strategy, when you also have the opportunity to make an active choice based on your retirement goals and income expectations, which in turn could lead to improved outcomes.
- The thrill of the ride
You hear ‘resource boom’, ‘tech boom’, ‘credit boom’ – and you want to take advantage, even if it means abandoning your long-term investment strategy. Sounds familiar? This is called ‘optimism bias’. This ‘glass half full’ approach to investing causes us as emotional beings to overestimate the probability of positive outcomes occurring (i.e. gains) and underestimate negative ones (i.e. losses).
“A wise investor is a calm investor”
Markets move and investments will always go in and out of favour. Sterling Planners aim to be responsive and keep our fingers on the pulse, without being re-active and trying to ride every wave. Sometimes it’s the decisions we choose not to make that count more.
At Sterling Planners we “stay calm and carry on”.