Nic Andrew, Head of Nedgroup Investments, discusses the behavioural aspects of investing, and highlights five behaviours that can hamper an investor’s rational decision-making.
People tend to think that investing is a numbers game, but successful investing has a lot more to do with personality traits than most of us realise. There is a large and deeply researched branch of finance which focuses on the behavioural aspects of investing and has highlighted a wide range of human biases that obstruct rational decision-making. Some of the most common topics explored in this field include the following:
Many investors are overconfident in their own abilities, which leads to investment decisions that are insufficiently researched and not as carefully thought-through as they should be. Related to this is self-serving bias, which is when investors attribute positive outcomes to their own knowledge and skill, while blaming negative outcomes on external factors such as “market irrationality” or unpredictable events.
Most investors have a tendency to think that recent trends will continue indefinitely into the future. As a result, they place too much emphasis on recent trends when making investment decisions, even when they are investing for the long term.
Many investors anticipate that they may regret having made the wrong choice and take this into consideration when making investment decisions. This can make them more risk averse to avoid possible losses, or it can lead them to take greater risks to avoid missing out on good returns.
It is well documented that investors are asymmetrically biased against losses. This means that most people perceive a loss of R1,000 with far more emotion than a gain of R1,000, even though their actual difference in wealth is the same.
Most people struggle to make decisions objectively. They tend to start out with a conclusion or a leaning towards a particular conclusion in mind and then find evidence to confirm what they wanted to believe in the first place. This often involves ignoring or dismissing evidence to the contrary.
At Nedgroup Investments, we have always believed that to be successful, investors should strive to manage their emotions when making investment decisions. This is easier said than done, but being aware of the behavioural factors that influence your thinking can help you make better financial decisions in future. The most important thing is to have a sensible framework and to have the discipline to stick to your plan.
For more on our approach, go to www.nedgroupinvestments.co.za