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Written by: James Norton
07/08/2020
It’s been a rollercoaster ride for investors and given the dips, our human instinct is to respond. How do you navigate these basic behavioural biases?

It’s been a turbulent year so far for shares. When the FTSE 100 dived more than 30% between February and March, it became one of the fastest bear markets in history.

By early June, the index had almost recovered before drifting down again into August, taking investors on a rollercoaster ride.

And it’s been the same in many international markets.

When markets become unpredictable and swing wildly like this, the temptation to do something is strong. Yet, research has shown that during periods of volatility the best thing investors can do is stay the course and ride it out. So why does our gut tell us otherwise?

This urge to respond in the face of an apparent challenge is basic human nature and one of the many hard-wired behavioural biases we have inherited from our distant ancestors. For them, these biases were probably advantageous in a dangerous world where food was scarce and reactions to fear and greed were rewarded in the fight for survival.

In the modern day, our behavioural biases can be less than helpful when it comes to financial decisions. Whether it’s being overconfident or overly sensitive to losses – or paying too much attention to the recent past or finding facts to confirm what we already think – such inherent biases can be dangerous for our wealth. What’s more, we can’t just switch them off.

So, what do you do? Well, an obvious starting point is to prepare a strategy to defend against the influence of your biases. After all, these instincts could soon come to the fore again.

With the way 2020 has gone so far, it wouldn’t be a huge surprise to see more market turbulence in the weeks and months ahead. In fact, it’s fair to say that volatility is part of investing and something more experienced investors tend to get used to. So when stock markets do get choppy again, there are some things you can do that might help you resist any impulsive decisions and stay on track to reach your goals.

Behavioural safeguards

Firstly, be aware of your biases. After all, you can’t fix what you don’t know. This sounds simple but can be harder to put into practice. For example, our oversensitivity to loss isn’t easy to supress – particularly when markets fall as sharply as they recently did. Just remember that impulsive financial decisions are rarely conducive to helping you reach your long-term goals.

The next time you are thinking of selling some investments or stopping your monthly savings plan, remember why you started investing. Remind yourself what your goals are. Because hitting your target is about patience, not short-term gains. If your aim is to achieve a comfortable retirement, for example, using your long-term goals to frame your decision-making will help keep you on track. A loss of 10% or even 20% over a one-year time frame should not cause undue concern over a 30-year investment horizon.

Managing behavioural biases is about overcoming emotional reactions to situations. So, it can be a good strategy to document your decisions. When you have decided how you want to invest and your reason for selecting certain funds, write it down. Consider writing down your goals as well.

When you next want to change the portfolio, check your notes and remind yourself of your original thinking. It will help you to learn from your mistakes and hopefully prevent you taking unnecessary action.

Develop a process to help remove some of the emotion from investing. Decide how often you’re going to review your portfolio. Monthly, or even annually, will do for most investors. Also decide how often you are going to rebalance your portfolio. Will it be annually or based on how much your holdings have moved? It probably doesn’t matter which method you choose, but when you have one, stick with it. That way, you don’t have to make judgement decisions on when to buy and sell holdings.

If that feels like too much work, there are funds out there that can do this automatically for you. These funds keep the asset allocation constant through a disciplined rebalancing process so you can maintain the right level of risk.

Many of us don’t have the time, willingness or ability to manage our investments, and that’s fine. If that’s the case, find a well-qualified adviser who can act as your coach and make these decisions. When selecting an adviser, it makes sense to check they have good processes and that their own biases are not too strong.

Lastly, remember that investing doesn’t have to be complicated or stressful. Buying a few low-cost, well-diversified funds and using your tax allowances where appropriate is really enough for most of us to achieve our goals. Then you can sit back and let your investments take care of themselves, checking occasionally.

The next time you want to trade, just ask yourself: “do I really know better than the market?” If the answer is “no”, which it usually is for most of us, the best course of action is probably to take no action.

James Norton is senior investment planner for Vanguard UK

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