Losses will be even greater in 2020 because of COVID-19 market volatility. So how can you overcome natural human tendencies to protect your investments?
The post The irresistible urge that costs retail investors 3% a year appeared first on Motley Fool Australia. –
A natural human need for “emotional comfort” costs retail investors 3% in lost returns each year.
However, United Kingdom behavioural finance firm, Oxford Risk, warned this week that losses in the year of the COVID-19 pandemic would be even higher.
This is because emotions take over even more in times of volatility.
“During a crisis, investors are likely to focus too much on the present and on the detail, feeling compelled to do something even when sitting tight is the best solution,” stated the company.
“They can gravitate towards the familiar – often leading to underinvestment, selling low, or decreased diversification.”
These behaviours are common to many investors, even experienced ones.
Oxford Risk Chief Executive, Dr Marcus Quierin, said such acts devastatingly result in turning theoretical losses into actual ones.
“If they don’t need to withdraw money for immediate expenses, then the losses are only virtual… until they panic and make them real,” he said.
“The investments in the news are not your investments. Retail investors should avoid watching the markets day-to-day as this will only increase anxiety to no useful end, and make you feel like you should be doing something, without any useful guidance to what that should be.”
If your original strategy was to invest for the long haul, Quierin said, then any market volatility should be viewed through long-term lenses.
Focus on what you can control
The Oxford Risk study found that many retail investors have increased their proportion of cash this year because of the volatility.
But this reluctance to invest would cost them 4% to 5% per year over the long term.
Losses due to timing — selling low and buying high — was calculated at an average of 1.5% to 2% per year.
Quierin said trying to time the market is a mug’s game.
“Investors should focus on what they can control. It’s the most ancient advice there is, and still the most important,” he said.
“You can’t move the market or predict when it’s at the ‘bottom’ or the ‘top’. You can postpone discretionary spending and use tumultuous times as an opportunity to take stock of your long-term financial plans. And you can control the opportunity to benefit from the ‘risk premium’ – the long-term reward for owning shares that has eventually weathered every short-term storm yet.”
The volatility of 2020 is perfectly demonstrated in the wild ride that the S&P/ASX 200 Index (ASX: XJO) has had.
When the market crashed in March during the first coronavirus lockdown, the index lost 36%. Then from that trough, it has gained more than 40% as at 11 November.
Oxford Risk develops software that assists financial advisers and institutional investors to overcome behavioural biases.
“There is too much guesswork and not enough technology. This means that assessment of client emotional proclivities is noisy, biased and prone to error… it is too subjective,” said Oxford Risk behavioural finance head, Dr Greg B Davies.
“This is not to advocate removing humans from the process… Human conversations are vital, particularly in a crisis, but advisers need to be assisted by better diagnostic tools enabling accurate assessment of the client’s personality and likely behavioural tendencies.”
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Motley Fool contributor Tony Yoo has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.
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