Investors often face a battle to remain rational, rather than emotional, in their decisions. Here, top wealth managers and wealth management experts explain the behavioural biases all investors must avoid.
Common behavioural biases like fear, over-risking, anchoring and “over-egging” investment themes have been the undoing of many an investor. Forewarned is forearmed, however, so the following tips from top wealth managers and both co-founders from findaWEALTHAMANGER.com might help you avoid some costly mistakes.
1. Fear
Lee Goggin, Co-founder of findaWEALTHMANAGER.com, says:
Fear prevents investors from making constructive investment decisions when they should. Fear is the force that stops a person from investing at the bottom of a market cycle or taking profit at the top – which is the obvious way to make money.
Fear of admitting you were wrong can also cause losses to be more extreme than they need to be. Investors can often ‘ride a stock down’ when it is plummeting rather than recognise their mistake, get out fast and limit their losses.
2. Over-risking
The FWM team at findaWEALTHMANAGER.com say:
A common issue we see with client portfolios is ‘over-risk’. This is where clients are positioned inappropriately for their risk profile. We see 100% equity holdings for DIY clients who think their portfolio is medium or low risk. Equities are undeniably higher risk. We also often see leveraged portfolios too – great when markets go up, very bad when markets go down.
According to our client research, 85% of private investors mis-categorise their risk objective to take on far too much risk for their profile.*
3. Believing hype
Rob Morgan, Pensions & Investment Analyst at Charles Stanley, says:
Most nightmarish investments I have seen have stemmed from supposedly ‘hot’ sectors that subsequently failed to live up to the hype. Many investors will have the skeleton of a technology or internet fund from the late nineties in their closet. Sadly, many ordinary investors were too late to the dotcom party; the area peaked at the turn of the millennium and some saw their capital decimated.
The lesson: a sector that proclaims to be ‘the next big thing’ is probably as big a red flag. The internet mania (eventually) brought a few success stories such as Amazon and eBay, but most companies failed spectacularly or never recovered their share price highs.
4. “Over-egging”
John Langrish, Head of Investments at James Hambro & Partners, says:
People can sometimes tend to think, ‘I don’t need an adviser; I can just day trade’. But the problem is that DIY investors tend to be hugely momentum driven; or they have a big theme and ‘over-egg’ it.
Taking pharmaceuticals as an example, an investor might hold three or four biotech stocks – some start-ups to play a theme – then they might have four or five large-cap pharma names too. They [investors] go for all the associated companies simply because in the past one has done well for them.
We do see some very impressive funds come over to us, but unfortunately, you will often find investors all in equities, all in one theme and all in one currency.
5. Anchoring
Chris Justham, Relationship Manager on 7IM’s London and South East focused discretionary team, says:
Behavioural finance discusses the concept of ‘anchoring’ – attaching thoughts to a specific reference point, which is all too easy if an investor feels that they have identified a theme.
If investors are not careful, this can lead to decisions being made on what may be irrelevant or out of date information. A great example of how quickly things move is the raft of measures taken on a seemingly day-to-day basis by the Chinese authorities during the summer. Both unexpected and swift, interventions like these change the landscape dramatically and can render previous assumptions redundant.
6. Knee-jerk reactions.
Duncan Carmichael-Jack, Partner at Vestra Wealth, says:
“It is worth bearing in mind that stock market liquidity is extremely low in the summer months. This tends to amplify the move in equities as there are few buyers when investors panic sell. It is also a time when company information on trading is much reduced, and headlines instead focus on geo-politics. Sparse data can create false signals and there is limited new fundamental information to merit any change in strategy. As a result, we believe it is best not to react to headlines when genuine news is so thin.”
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