Breaking the cycle of emotional investing
Breaking the cycle of emotional investing
7 Aug 2022
Breaking the cycle of emotional investing
Sorted Money Week (8-14 August) starts tomorrow, and with it, a timely cue to have open money talks – to get support, bounce off ideas, challenge your biases, and learn new things.
Without these conversations, investing can feel like a pretty solitary and emotionally-driven pursuit, especially in times of market volatility. Rationally, you know that there are both upsides and downsides to volatile markets. And you know, based on history, that the markets will eventually rebound. But even so, when you see your savings drop, emotions can be hard to rein in.
So, what can you do to break the cycle of emotional investing? In our recent podcast - News of the Money World co-hosted with NZ Everyday Investor’s Darcy Ungaro - Kōura Founder, Rupert Carlyon shared some ideas on how investors can make this rollercoaster ride more comfortable. Here are some key takeaways:
It’s easy to get caught off guard
Let’s face it: downturns are not something most investors are used to. Rationally, we all know that there will be ups and downs along the way; it’s just how investment markets work. But having been in a bull market since 2009 (apart from the short interruption of the Covid-19 crash in 2020), you’re probably not familiar with how downturns feel at a ‘gut level’. That’s part of the reason why, during volatile times, controlling your emotions is so challenging.
How behavioural biases get in the way
As we pointed out in a recent article, as an investor, your personal instincts are not the best tools for making good decisions.
Our emotions stem from a number of ingrained behavioural biases, like our natural tendency to try and fix things (even when they’re outside of our control). Moving to a lower-risk fund during a downturn is a typical example of how this mentality can hurt your long-term investments. Your emotions tell you that you need to protect your investments from falling further, but what you’re actually doing is selling when the market is low. And as a result, you’re essentially ‘locking in’ your losses.
Another way that emotions affect investing is overconfidence in your own judgement. ‘I know best’, says the overconfident investor – better than what the theory dictates, better than what the markets assume. Unfortunately, markets move too fast to be predictable, and overconfidence can often come at a dear price.
The bottom line? No one knows the future. You can only draw some lessons from the past – and even so, always with a pinch of salt.
Learning and unlearning from the Covid-19 crash
The Covid-19 sudden downturn of March 2020 is still fresh in the memory of many investors as the infamous ‘Big Switch’. That’s when the markets suddenly crashed and thousands of KiwiSaver members (seven times more than average) switched into lower-risk fund types, hoping to protect their hard-earned money. Little did they know that only six months later markets would have completely recovered their losses. Unfortunately for them, the horse had already bolted.
Two years on, thanks to that hard lesson, there seem to be more educated conversations around KiwiSaver. More people have grown to understand KiwiSaver’s long-term nature and the importance of staying the course, as long as their risk profile doesn’t change.
On the other hand, given how short-lived the Covid-19 downturn was, some people may be under the assumption that this downturn will only last a few months. It may be the case – no one knows for sure – but historical data suggests otherwise. On average, market downturns last two to three years: so emotionally speaking, that’s the scenario that investors need to prepare for.
Thinking of switching providers?
So, you’ve been happily invested with the same provider for quite some time, but over the past couple of years, returns have been subpar. The question is, is a weak performance reason enough to change providers?
The key thing is not to judge funds based on performance alone, but rather understand why a provider has achieved certain returns. What’s their strategy? And does their asset allocation align with your goals and values?
Also, keep in mind that, while providers may outperform the market on a one-year, three-year, or even five-year basis, it’s very rare that they can continue to do so in the longer term. And that’s why it’s a good idea to choose your provider based on fundamentals like fees and asset allocation first, and performance second.
Meanwhile, here are three things you can do to keep emotions at bay
Even if you consider yourself a rational being, make sure you don’t underestimate how much emotions affect your decision-making. That doesn’t mean being unemotional or purely logical. It means identifying what’s driving you and turning down the noise, because one of the worst things that you can do is to use short-term data to make long-term decisions.
In our News of the Money World podcast episode, we touched on three practical tips to keep yourself safe from yourself:
● First, flip the script and reframe what you’re going through into something positive. Instead of looking at how much you’ve lost and can still lose, you can focus on the opportunities ahead.
● Second, consider setting rules to avoid impulsive decision, like having a sort of waiting period before any decisions can be made.
● And third, make sure you find people that you can talk with. Having conversations about money can help you view things from another perspective, and with more clarity. It could be your peers or, even better, a financial adviser. After all, it’s their job to challenge you and share their knowledge, so that you can make better-informed decisions every step of the way.
Do you have any questions for us?
Sorted Money Week (8-14 August) is back next week, and once again, it’s focused on encouraging Kiwis to talk more openly about their finances and seek help.
Just wondering? Just ask – here at Kōura, we’re all about empowering people on their lifelong financial journey, with quality digital advice. Click here to get started.