Don’t derail investments

BEHAVIOUR GAP: INVESTORS BUILD PERFECT PORTFOLIO, ERRORS BLOW IT UP

As markets rise, investors pile in, but when stock prices start falling, they head for the exits. Moneyweb

Imagine someone walking into an Audi dealership and telling the salesperson that he would like to buy an A6. “Wow, I’m so excited for you,” the salesperson replies. “Your timing is perfect. We just marked them up 30%!”

“That’s awesome. I’ll take three!” Not a realistic sketch? Of course, not. Almost no one would behave this way. And yet a similar situation plays out in investment markets on an ongoing basis. As markets rise, investors get excited and pile in, but when stock prices start falling, they get scared and head for the exits.

Other than in investment markets, there is no other place he could think of where humans behaved like this, Carl Richards, Sketch Guy columnist for The New York Times and author of The Behavior Gap, told the Alexander Forbes Investments IFA Symposium, referencing the Audi example.

He believes overcoming this “behaviour gap” – the distance between what investors should be doing and what they actually do – is important to meet long-term investment goals. Ultimately, behaviour plays a bigger role in reaching investment goals than returns. Investors can build the perfect portfolio, but behavioural mistakes can blow everything to pieces.

“The investment process only matters to the degree that it influences behaviour, because without [appropriate] behaviour it is no good,” he told Moneyweb on the sidelines of the conference.

It was the rare individual who didn’t sell his or her stocks during the 2008/2009 global financial crisis, but sitting in cash meant that investors missed out on a significant stock market recovery during the next few years, he said.

As investors, we know what we should be doing. Why aren’t we doing it? Richards said it is an almost genetic trait. Humans desperately sought out security or pleasure and avoided pain. This has often wreaked havoc with investments. “When markets are going up… and everybody else is happy and the news is happy, we want more of that and then when markets are low, when we have a normal down market which happens and will happen again, we view that as painful.”

Managing these feelings is a challenge.

Overcoming the exuberance when markets are running and the fear when markets are falling, requires investors take themselves away from the product, markets, the economy and the news and back to the foundation – their financial plan, which is built on their goals, he said.

They have to remind themselves of their goals and not their investments based on market changes, but based on changes to their goals, assuming they are diversified.

Managing these feelings is a challenge.