We tend to bring our biases everywhere and we interpret information according to these biases. It is human nature and often hard to escape. We tend to be heavily influenced by recent and previous events or trends. In order to become a better long-term investor, there are some things to know.
Information and News
Every day we are bombarded by new information and investment news, which we use to make decisions. This should be a taxing process, but our brains make it easier by using mental shortcuts that help us make a quick decision without the need for lengthy analysis. These mental strategies are known as heuristics. Heuristics may help us save time, but may lead to errors in judgment. There are many behavioral biases and some of them should be all too familiar: Biases that affect our decision-making processes include anchoring (relying heavily on one piece of information), over-confidence, fear, confirmation bias (only searching for information supporting your belief), over-extrapolation and greed, to name but a few.
Investments require time to be successful. The triggers, mistaken beliefs and psychological traps that drive our investment behavior often cause irrational acts, which can destroy wealth.
Consider the Global Financial Crisis: Equity funds enjoyed excellent returns in the 5 years leading up to the 2008 crash. These returns caused investors to flock to the stock market, which drove the market even higher. Then came the crash and those very same biases, that once drove investors to the market, had led them to the biggest sell-off in the market’s history. Many investors found that, had they not succumbed to their biases, their losses would have existed largely on paper.
In fact, investors who did not give in to their emotions managed to make back their losses and, in some cases, almost double their money (in absolute terms) by September 2016.
It is important to note that this strong recovery was in part driven by the monetary policies devised by the central banks to increase asset returns globally. Previous market crashes have taken longer to recover in absolute terms and longer when one accounts for inflation.
What about stable funds?
Stable funds function to protect the investor’s capital. If you are averse to risk and seek stability then this is probably the best fund for you. This doesn’t mean that some investors in a stable fund are immune to emotional behavior. Many investors in stable funds tend to over-extrapolate short-term performance trends, which in turn informs their decision to invest or withdraw. The problem arises when investors withdraw on a downward trend and thus don’t benefit from the performance on the inevitable upward trend. This is why they don’t achieve the same returns as the unit trusts in which they are invested.
So what should you do?
Overcoming one’s biases can difficult, but the first step is identifying them. Try and assess the information you receive and only use it when relevant. This increases your chances of seeing a better outcome. It is a good idea to find an investment manager you trust, who employs an investment philosophy that aligns with your goals. Make sure you understand the unit trusts you have invested in. This will make it easier to remain calm during periods of fluctuation, allowing you to benefit from the eventual upturn.
Dips in performance lead to lower prices, which generally makes it a good time to add to your portfolio (if you have the means to expand). In the end, it is the combination of heuristics/investor behavior and market/fund performance, which determines investor returns.
Try and identify your own personal biases and try to overcome them. This will allow you to make more rational decisions. Listen to your financial advisor and stick to an investment strategy tailored to your needs. Short-term market volatility is common and should not affect your long-term strategy. It’s easy to slip into old patterns, but a good financial advisor can help you make rational sense of all the information you have and help you stick to your plan.