4 Little-Known Tips To Counter Your Investment Biases
In our last article, we talked about how easy it is for human beings to make irrational investment decisions – often based on fear, misinformation or raw panic.
As financial advisers, the basic argument we often make relates to “Behavioral Finance”. Essentially, this makes the case that people tend to be biased in their investment decision-making.
In other words, humans are not naturally or purely rational when it comes to money. This is hardly very controversial, but it is a crucial point. The key question is, of course, what can be done about it?
Can we actually do anything to mitigate against emotional and behavioral bias and make intelligent, rational decisions about how to deploy our financial resources?
This post is going to be somewhat practical, shedding light on some of the tips we give clients in Lincoln when we deliver investment advice on their portfolios.
We hope you find it enlightening, and would love to hear your thoughts as well.
1. Distinguish Speculating From Investing
Whenever we give financial advice, we stress how investing is a long-term endeavour (usually a minimum of 5 years, but preferably over the course of an economic cycle). In this, you are looking to gain from the longer-term trends of the markets.
Speculating, however, is more about “quick wins.” In other words, you look for a return on your money within hours, days, weeks or a short space of time. “Get rich quick” schemes typically fall into this category, and can be financially fatal.
This isn’t to say there is no place for speculation. Some might even say it is good to roll the dice every now and then, provided it is an amount of money you can afford to lose.
However, we would never advise someone to commit all their financial planning to speculative activities. If you are investing for the long term, then diversification, asset allocation and discipline are key.
2. Participate In The Market – Do Not Try And Beat It
This often comes up in our conversations with clients in Lincoln. Think about it:
When people try and beat the market, they think they have access to knowledge not already available to money managers on the stock market. But where can they possibly get this knowledge from?
The most plausible answer is first-hand experience. However, how can your experience (or indeed anyone’s) fully cover all the asset classes and sub-sectors comprising the markets? It’s impossible.
This is why it is a bad idea to gamble and “play the markets” with short term speculation in an effort to beat them.
Certainly, there have been exceptional individuals who have managed it, such as Warren Buffett (who is worth billions).
However, even the best investors usually fail to consistently beat the market over time. This is why it is usually a bad idea to pick individual securities, rather than use a strategic blend of asset classes and diversified funds.
For most people, an appropriate mixture is going to be the more sensible way forward, consistent with your risk appetite, capacity for loss, objectives and investment time horizon. This means that your investments achieve your objectives.
3. Asset Allocation Is Your Engine
There are many different asset classes available to clients of financial advisers. In our conversations with people in Lincoln, we draw attention to the likes of equities, bonds, property and ‘alternatives’ (e.g. commodities and infrastructure) investment classes (to name just a handful).
Each asset class has its own broad advantages and disadvantages. Shares, for instance, tend to be riskier than bonds (fixed interest securities), but have the potential for a higher return over the longer term. It is how particular asset classes are blended and managed going forward that is crucial.
The key thing here is to determine your investment goals, and work with an independent financial adviser to build a carefully constructed, diversified and regularly rebalanced investment portfolio – one drawing on the best from the wider market. This should comprise an appropriate blend of different investment classes, styles of investment management and investment managers based on your agreed risk profile, financial circumstances and objectives.
4. Trends Are Normal – They Work Both With & Against You
When you have a diversified investment portfolio (i.e. one containing different asset types as mentioned above), then it is completely normal for some parts of it to do well at a given time, and yet other parts of it might simultaneously be doing not so well – or even badly!
Recognise that this is common in even the best and most successful portfolios. It is usually impossible to predict when one part of your portfolio will do well and other parts will not. This is when regularly rebalancing a portfolio can add value, effectively taking gains from profitable parts of your portfolio and reapplying them to parts that are (currently) out of favour but offer the potential for better returns in time.
Also, bear in mind that if you try and follow popular trends, you are usually set for trouble. All too often, it leads to participation in investment “bubbles” which will eventually pop and which have has devastating results e.g. the Technology crash of 2000.
Remember, changes made to your investment strategy should never be based on the changeable economic conditions – but rather because of changes to your circumstances, risk profile or objectives.