01
February
2016

Fighting human instincts

investing human instincts make us make bad investment decisions

When it comes to investing human instincts make us make bad investment decisions, as an advisor our role is often encouraging our clients to ignore some of these instincts and stick to their plan.

Had a classic example of this during a recent client review, after discussing the client’s circumstances and goals we had a look at the progress of their superannuation, with the markets performing poorly over the past 12 months the value of the portfolio had fallen by about 4%.

The client was quite concerned about this loss and was immediately thinking about safer options. Under closer inspection, the client over the previous 3 years had made over $40,000 dollars and averaged around 10% return.  This is above the long term expectations for the investment.

Once viewing the longer time frame, the client was comfortable with the investment and was happy to continue with the long term investment strategy.

But what makes us forget the 3 good years of return and focus on the negative year, that the client was more than aware was going to happen at some point?

There are two human instincts that have been drilled into us through years of evolution that have helped the human race survive and thrive, but hurt us when making investment decisions.

The first is “recent event bias”, this is essentially giving the most recent event greater importance than all previous events. This normally helps us, as it allows us to adapt to changing environments. For example if overtime a road gets busier and busier we take caution close to the last time we crossed the road, not the long term average. This of course makes sense with most things. Our most recent encounter with something is usually the most relevant to how we deal with it in this encounter.

What happens with investing, this causes us to look at short time frames and assume that recent returns are most likely to replicate upcoming returns. This is of course not true, and in fact quite the opposite, after a reasonably sustained period of growth, we are likely to experience a correction and the market will fall to its “true value”, and the reverse is also true, often a market loss is followed by an above average gain the following year.

Looking at these shorter periods is likely us to do exactly the reverse of the common mantra, we are likely to buy high and sell low. Definitely not what we know we should do.

The other human instinct is that fear of loss is far greater than the hope of gain. There have been numerous studies which indicate that most humans are far more motivated by fear of loss, than they are by the opportunity to make a gain. Evolutionary speaking, this stops us from doing stupid things and really increases life expectancy.

When it comes to investing, this can really lead to panic when markets fall. The fear of losing more money far outweighs the opportunity for the investment to bounce back. This often leads to panic selling. All of a sudden the client has forgotten about the 3 years of great returns that have seen the investment grow and can only see the loss.

Although I can logically tell you, that if you put your money in a balanced investment for 10 years, and leave it, we can predict with reasonable accuracy a range your investment will end up, in leaving it for 10 years we have to at times fight our instincts and remember the long term plan. Easier said than done at times, and sometimes the most value an advisor can offer you is to protect you from your instincts.

Author; Alex McKenzie Categories: Future Financial Services Blog

About the Author

Alex McKenzie

Alex McKenzie

Owner at Future Financial Services

Past:

  • Paraplanner at Zammit Partners Investments
  • Unit Trust Administrator at Colonial First State

Education

  • University of Western Sydney
  • Penrith High

About

As a Financial Planner I help people to achieve what they would like in life. This involves helping you to identify the things in life they would like , developing plans to help achieve them and strategies to protect what you already have. We do this by providing Financial Advice to guide you through your life stages.

The financial planning process involves determining a clients current situation and financial objectives and tailoring strategies to assist in best achieving those objectives.

I am an expert in superannuation, investments and insurance, these are tools we use to help you achieve your goals.

I aim to use my knowledge of superannuation, taxation and Centrelink to efficiently use your assets and income to achieve your financial goals.

Retirement and pre-retirement planning, wealth creation, asset protection, insurance planning and estate planning are all areas of advice that I provide.

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