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Investing behaviours to avoid – thinking objectively in times of uncertainty

In times of uncertainty, it’s important for investors not to lose their cool and let bad behaviours sneak in. Here are some of the main investor tendencies to look out for, and how to try and avoid them.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

2020 will mainly be remembered as the year coronavirus took over. It’s had a devastating impact on human lives and changed the way we live. It’s also accelerated lots of existing trends and kick started new ones.

From an investment perspective, the virus created a year of diverging investment performance across different parts of the world. Markets like the US excelled by delivering returns of 17.1%, powered by its market leading technology businesses. Whereas other markets like the UK’s lost 9.8%. Past performance isn’t a guide to the future. (Source: Lipper IM to 31/12/2020).

But stock market performance doesn’t always reflect what’s going on day to day on the ground in the economy. Many of the world’s leading economies have suffered badly as businesses haven’t been able to open and spending has dried up. Headlines on the economy have been unsurprising, with big initial falls in GDP taking centre stage. In 2020, world real GDP fell 3.6%, the worst growth outcome since 1946.

All of this has made navigating the past year tricky for investors. While there now seems to be light at the end of the tunnel, it doesn’t look like uncertainty will be going anywhere soon.

But in times of uncertainty, it’s important for investors not to lose their cool and let bad behaviours sneak in. Here are some of the main investor tendencies to look out for, and how to try and avoid them.

This article isn't personal advice. If you're not sure whether an investment is right for you, please ask for financial advice. Investments rise and fall in value, so you could get back less than you put in.

Following the crowd and overconfidence

Not even the best investors get every decision right. As investors we aren’t always rational and can be guided by emotional decisions instead of logic. But it’s important to give yourself the best chance of investing success by being aware of a few simple things to help avoid some pitfalls and unnecessary stress.

The first is ‘following the crowd’. This has been behind some of the extreme volatility in the share prices of some previously low-profile US companies we’ve seen recently.

It’s easy to become excited and feel like you could be missing out on something when you see what seems like a great tip online. But as is often the case when there’s short-term hype, while some investors might be able to make a quick return, lots will lose out. It’s important to do your research and not jump the gun before making an investment decision.

A good way to think of any new investment is to decide if you’d be happy keeping hold of it for ten years. As legendary investor Warren Buffett says, “If you aren't thinking about owning a stock for ten years, don't even think about owning it for ten minutes.”

Another well-known bias is overconfidence and people’s tendency to have an unwarranted confidence in their own abilities. There’s nothing wrong with being confident when investing, but too much of it can be risky.

Research has shown that overconfident investors take more risk and tend to trade more frequently, but this can negatively impact their returns over time. Over the long term, this has the potential to reduce the value of your investments and leave you further away from reaching your investment goals.

How risky is your portfolio?

Loyalty or irrationality?

Some investors can also suffer loss aversion bias. This happens when investors are reluctant to sell an investment at a loss, and use the money to invest back into other ideas – ultimately adversely affecting their portfolio.

Why does this happen?

Often it can be because we’re more sensitive to making a loss on an investment than making a gain. After all, no-one wants to see that figure in red.

Making the call that it’s time to sell and move on can be difficult though. It could be a stock or a fund that’s banked you a profit in the past, or one that’s paid you an income. This can result in having an emotional as well as a financial attachment to it – this loyalty can cost you though.

As ever, investors shouldn’t look at past performance as a guide to the future.

Often reaching a decision means looking inwards first and considering your decisions in the past. Did you make a mistake when buying the investment initially? Or has something changed since then which means it’s not the prospect it once was? Or even, is there still a reasonable chance the investment will become profitable again in the future?

There’s also the opportunity cost to consider of course. Or in practical terms, if I wasn’t holding onto this investment what else would I be doing with the money, or where else could I invest it? Asking this can help to clear the clouds and help you to weigh up the alternatives. A good question to ask could be, if I didn’t already own it, and were analysing it fresh today, would I invest?

If the answer’s no, then it might be best to sell it and move onto something else.

So what should investors do?

Investing shouldn’t be driven by emotion or what other investors do. Investing is personal. It’s there to make your life better and help you reach your own financial goals.

Avoiding these bad tendencies can be tricky, but it’s important to at least be aware of them. While you might not be able to avoid them all, you can put yourself in a good position so any slips don’t end up costing you too much. The best way to do this is through a well-diversified portfolio.

This should include different types of investments that invest in different sectors and parts of the world.

If you invest in funds, you should hold a range of funds with managers who have different approaches and investing styles, including different investment philosophies, like value and growth.

Growth vs value investing – what’s the difference?

If you invest in individual companies, you should only buy and hold individual shares as part of a well-balanced, diversified portfolio. Investing in shares is higher-risk and isn't right for everyone, so anything you hold should match how much risk you’re happy taking and your investment goals.

Being well diversified should improve the resilience of your portfolio as the economy changes and new surprises emerge. It’ll give your portfolio a better chance of performing well over the long run and help you achieve your goals.

Diversification – the investor’s tool we all need to talk about

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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