Investments

… to those who wait

‘Patience is bitter, but its fruit is sweet’

Aristotle

Good things come to those who wait.  This was the strapline once used by Guinness to refer to the 119.5 seconds it takes to pour a ‘perfect’ pint of their iconic stout[1]. With investing, the time periods we are concerned about are measured in years, rather than seconds.  Looking at your investment portfolio too often only increases the chance that you will be disappointed.  This of course can be challenging at times, particularly during tumultuous markets.

We know that monitoring markets on a monthly basis looks rather stressful, as they yoyo through time whereby there are times during which the market is growing its purchasing power (i.e. beating inflation) and there are times when it is contracting.

The evident day-on-day and month-on-month yoyo is a consequence of new information being factored into prices on an ongoing basis.  Investors around the world digest this information, decide whether it will cause a change in a company’s cashflows (or the risks to them occurring), and hold or trade the company’s share accordingly.  These are the concerns of active investors casting judgements on an individual company’s prospects.

Over longer holding periods, the day-to-day worries of more actively managed portfolios are erased, as equity / share markets generate wealth over the longer term.  For instance, between January 1988 and June 2020, monthly rolling 20-year holding periods never resulted in a destruction of purchasing power.  A longer-term view to investing enables individuals to spend more time focusing on what matters most to them and to avoid the anxiety of watching one’s portfolio movements.

This is not to say that investing is a set-and-forget process, however.  Wells Gibson’s Investment Committee meets regularly on your behalf to kick the tyres of the portfolio, after reviewing any new evidence.  Over time there may be incremental changes to your investments (or there might not be) as a result, but the Investment Committee shares the outlook illustrated in the figure above – we have structured your portfolio for the long term, and it is built to weather all storms.

Delving deeper

If we look at longer term market data in the US back to 1927, the result is the same.  Furthermore, we can cherry-pick a 20-year period which is fresh in many investors’ minds: the bottom of the Financial Crisis. In this (extreme) 20-year period, to Feb-09, equity markets had barely recovered from the crash of technology shares in the early 00s, before falling over 50% in 2008/9, in real terms.  These were unsettling times to say the least.

Despite the headwinds, investors had been rewarded substantially for participating in the growth of capital markets over the longer term.  An equity investor viewing their portfolio for the first time in 20 years would have seen their wealth more than double, whilst at the same time the media was reporting headlines such as ‘Worst Crisis Since ‘30s, with No End Yet in Sight’[2].

Have faith in wealth-creation through capitalism and try not to look at your portfolio too often. As the adage goes: ‘look at your cash daily if you need to, your bonds once per year, and stocks every ten’.

Header image by Sarah Mitchell-Baker on Unsplash; York, UK, Looking over the River Ouse in York from Lendal Bridge.

[1] https://www.guinness-storehouse.com/en/guinness-academy

[2] Wall Street Journal, September 18, 2008

Behavioural biases play a significant role in our decision-making as investors.

Whether we realise it at the time or not, these inherent biases can sometimes contribute more to our portfolio returns than the assets or funds we select.

A new briefing note from investment software provided Dynamic Planner has highlighted the value of understanding behavioural biases, along with other factors, to improve investment outcomes massively.

Dynamic Planner explains that there is extensive evidence about the impact of behavioural biases on investment decisions. But the factors that influence our susceptibility to these biases are less well covered.

By understanding how personality traits and behavioural biases influence our investment decision making and then taking some steps to counteract them, we can reduce the likelihood of making poor investment decisions.

Dynamic Planner identified five essential traits that define personality. In psychology, it is known as the Five-Factor Model – this includes openness to new experience, conscientiousness, extraversion, agreeableness and neuroticism. All of these factors have various facets to them.

The Five-Factor Model

Conscientiousness

This is the extent to which we are dependable, orderly, organised, responsible, practical, thorough or hardworking.

Neuroticism

This occurs when we’re feeling depressed, tense, nervous, angry, unstable, envious, worried or uneasy.

Extraversion

This is what drives us to be sociable, outgoing, energetic, talkative, bold, assertive and adventurous. Introversion often would make you low in this factor.

Openness to experience

This is what has the characteristics of being creative, imaginative, intelligent, analytical, reflective, curious and open-minded.

Agreeableness

This includes the characteristics of being courteous, polite, trusting, nice, kind, gentle, pleasant and sympathetic.

By considering each of the five personality traits, Dynamic Planner has explained how the characteristics fit with well-known investment behavioural biases, along with five ways in which investors can reduce or avoid these biases.

Dynamic Planner outlines below how these characteristics fit with the well-known investment behavioural biases along with five ways clients can reduce or avoid them:

Photo of people queuing by Halacious on Unsplash

Herd mentality

​(agreeable and/or introvert personality traits)

This relates to investors basing their decisions on the actions of others. Whether spurious (making similar decisions to others) or intentional (deliberately imitating behaviour) herding, both can be detrimental.

Investors can avoid herd mentality by not trying to time the market – this can be typical of investors engaging in herding behaviour. Such investors risk making losses and missing out on the highest periods of growth. It is, therefore, best to stay invested and follow the plan.

Anchoring bias​

(conscientious, agreeable and/or introvert personality traits)

Investor decisions can be influenced by fixating on a reference point due to uncertainty of assets. They then go onto make comparisons and estimates based on this which is known as anchoring, even though the reference point is arbitrary and irrelevant.

Anchoring can result in the ‘disposition effect’ where subsequent investment decisions can be negatively affected by holding onto losing stocks or funds for too long or selling winning ones too early.

To avoid anchoring bias, ​investors must be objective, communicate with their financial planner and/or make research-based decisions to be less vulnerable to anchoring.

Overconfidence bias

(extravert, openness to experience and/or disagreeable personality traits)

Investors who are overconfident and overoptimistic may take greater risks.

Overconfidence can manifest in an overestimation of investment knowledge and result in an underestimated perceived level of risk. It can also be increased by ‘confirmation bias’ – where new information that supports an existing opinion increases confidence.

To avoid overconfidence bias, investors need to consider the consequences of their actions!

Overconfidence can lead to attempting to time the market due to a perceived level of skill and illusion of control. However, when things go wrong this can result in a greater loss.

​Regret aversion

(conscientious and/or emotionally unstable personality traits)

Anticipating regret and envisioning the emotional discomfort of making a poor decision can result in inertia, where investors fail to act or stick with a default option for fear of making an active choice which later turns out to be sub-optimal.

To avoid regret aversion, investors need to have a​ ​systematic approach – following a plan with a diversified portfolio focused on long term investment goals will help investors regulate emotions and avoid succumbing to feelings of fear and regret.

Investors sometimes fall victim to the following:

​Recency bias​

(emotionally unstable and/or closed to experience personality traits)

Investors evaluate the likelihood of future events on recent memories without putting them in the perspective of the longer-term past.

This often relates to information that is easily accessible and available which can lead to poor investment choices.

To avoid recency bias, investors should have a long-term view for long-term investments to avoid short-term thinking which can lead to recency bias.

Louis Williams, Dynamic Planner’s Head of Psychology & Behavioural Insights said:

“Behavioural biases can influence risk tolerance levels and impact investment choices. However, if advisers can make investors more aware of the powerful biases that can influence their attitudes and behaviour towards financial risk, they can also help them to manage their investment journey in a much more positive way.

“Helping clients to have a much deeper understanding of their own personality and attitude to risk can be a great help in overcoming rash or ill-thought-out decision making when it comes to investments, especially when faced with unpredictable markets or a backdrop of uncertainty such as what we have experienced in recent months with the impact of coronavirus and Brexit transition. While unlikely to happen, if all investors were able to harness the ability to manage the well-known investment behavioural biases, there would be a directly positive impact on the volatility and fragility of markets.”

Header image by Andrew Buchanan on Unsplash

Photo of people queuing by Halacious on Unsplash