In this first episode of a six-part podcast series entitled “Emotions and Money”, Maya chats with Paul Nixon, head of behavioural finance at Momentum Investments, about “behaviour tax” ‒ the true cost of our poor investment decisions.
What is behaviour tax?
Research conducted by Momentum has found that investment returns are negatively impacted when investors switch between investments either due to fear (when markets have become turbulent) or greed (being attracted by the performance of a different investment). Researchers dubbed this effect “behaviour tax”.
When markets crashed in March of 2020, extreme fear saw investors selling out of shares at the dip. These same investors were then left scrambling to buy back in as the recovery took only three months. Over R650 million in investment value was destroyed ‒ this is the behaviour tax: buying high and selling low.
Momentum calculated that in 2020, this behaviour shaved 6.5% off South Africans’ investment returns; in 2021 that figure was around 3.5%.
ABCD behavioural framework
The ABCD behavioural framework is easily applied to our investment choices, and helps to explain this behaviour tax.
A is for Attention
Firstly, our limited attention is drawn to investments that have performed very well or very badly (often by news and media). This leaves us greedy to take part in high-yielding investments that make us look smart on the one end and fearful of our past investment choices on the other end, as yesterday’s winners often become today’s losers in a normal cycle.
B is for Belief
We’ve just outlined a belief system ‒ a way to make sense of a complex world using shortcuts or heuristics. We buy investments that have performed well and sell those that haven’t. While this sounds good, the world doesn’t work that way (quite the opposite, in fact). Following this strategy means that we often end up in the wrong place at the right time and miss out on the returns we deserve. Everything is cyclical and it’s impossible to predict tomorrow’s winners on yesterday’s results, because we don’t know where the turning points in the cycle are.
C is for Choices
This belief system informs our investment choices. Unfortunately, we don’t focus on the things that matter, like investments designed to achieve our goals and we are often overloaded with too much choice – over 1,500 unit trusts to choose from.
D is for determination
Finally, this ultimately leads to determination or willpower problems as we become despondent with a strategy that’s not yielding the desired results, and find it difficult to stay invested.
Sadly we often end up trading off future investment returns for short-term emotional comfort. Often what feels right is the opposite of what’s right for our investments.
Emotions and Money is a six-part podcast series in partnership with Momentum Investments, in which we unpack the psychology behind our investment decisions and how our emotions could be sabotaging our financial outcomes.