Who is your worst enemy?
Tuesday, 7 October 2008
The answer is you! Unfortunately investors can become their own worst enemy.
It is vital that investors invest with a Plan …yet every time we review a new clients portfolio, the plan is not systematic. We believe an investment advisor must clearly identify the risk aversion, risk preferences, and risk perspective of the investor, and in this way use a psychologically justified risk concept. To meet this goal a risk profiling questionnaire is indispensable. The discussion about risk is essential to our client discussions.
I recently attended a seminar regarding behaviour finance. The speaker was Prof. Dr. Thorsten Hens. He is Director of Swiss Banking Institute, Professor of Financial Economics.
He has listed “The Ten most Common Investment Mistakes”. They make interesting reading.
"You may delay, but time will not" – Benjamin Franklin
Many investors feel that investing is a very challenging task, and continually put it off. It is put off to the next time, and again to the next time, until they eventually become aware that a big portion of the return opportunities have gone because they didn’t take the time to make investment decisions.
"This week was sunny, so tomorrow I leave my umbrella at home"
If stocks have granted good returns for a few years, many investors will invest again in the stock market. They are so focused on attractive returns that they underestimate their risk tolerance. They have forgotten how much nerve it takes to stay invested in the stock market during a downturn. A rude awakening is sooner or latter inevitable.
"Betting on the winner who already won"
People are “adaptive learners” according to psychology. Practically, this means: if something gives us success we will be inclined to do it again. Only with failure do we change our behaviour. Unfortunately this strategy is not useful in the financial markets. Whoever follows the masses and holds the investments which have until now been successful, has a slim chance of winning returns, and is not invested when the biggest winnings are available. Although difficult considering our innate “herd instinct,” successful investors like the American investment guru Warren Buffet remain anti-cyclical and refrain from running with the herd.
"Market prices disclose all"
To analyze the fluctuation of market prices can be fascinating, but this effort is not profitable. The fluctuation of asset prices does not on its own hold any valuable information, contrary to the indications of numerous business studies. The study of price fluctuations reveals that investors too quickly believe a market move is a trend, and too quickly pull out of profitable investments, because they are afraid that “the end” is near.
"Always staying on the ball"
Psychological research shows that the more often one looks at the progress of a risky investment, the less and less inclined one is to remain invested. A risky investment does not only move upwards. Psychologically, losses hurt more than gains make one happy. For this reason, those who look too often at their investment cannot endure the fluctuations. They forget that the probability of realizing a loss on the financial market decreases as the investment time horizon increases. For this reason investors give up a large portion of the long term returns available to them.
"The odd charm of losers"
Private investors too quickly cash-in on short term winners and wait out losers for too long. If they make an investment decision, then the subsequent decision is not made with consideration for the future, but rather made with consideration only for the past. After a win the investor cashes out of the market and is proud to show off that his initial investment strategy was successful. The opposite is true in the case of a loss. To avoid accepting a loss investors wait in the hope that the investment can redeem itself.
"Glitz and Glamour"
Exciting stories advertise themselves better as boring. This is true in the financial market just like in media. Investors prefer to invest in ‘exciting’ ideas, for example in fascinating new technology, than to invest in well known ideas. However, in the long term, the economic results of the ‘boring stories’ prove them to be desirable solid investments. This phenomenon, the so-called value anomaly, has been known in science for more than a hundred years, and can be observed in almost every region of the world.
"Better 3 possible good stocks than 100 underperforming stocks"
The above quote appears to be plausible but is wrong from a scientific point of view. A broad diversification is worthwhile. It is enormously difficult to forecast which stocks or investment funds will be good or bad in the future. For this reason it is worthwhile to spread out the risk. Many studies have shown that private investors are significantly under-diversified. They distrust stocks from other countries, and limit themselves too strongly to their home market. In this way they forgo a large portion of the return opportunities.
"Gone with the Wind"
Many investors feel that they can pilot the investment process themselves. Too often the result is an unclear strategy. Like a leaf in the wind, investors move back and forth. They change their portfolio too often by buying and selling, so that they pay a great deal in transaction fees. This behaviour is of course good for the bank’s wallet, but consider ‘back and forth makes the wallet empty.'
"I actually knew that"
It is said in old wives tales that one learns through mistakes. This is not always true. To the contrary: when one experiences a financial mistake resulting in loss, it is a natural reaction to forget why the investment was a mistake. In retrospect many tell themselves that they actually knew what the right investment strategy was, but for some dumb reason they didn’t do it. This recurring phenomenon prevents us from learning from our mistakes.
posted by Murray Round Wealth Management @ 14:26,
The Authors
Nicholas Round
Nic is the Managing Director of Murray Round Wealth Management Limited, who seeks to ensure the advice provided is truly independent. Based in Shropshire with clients local, national and worldwide, Nic has strived to find the best possible service for his clients needs, by researching and studying the market, trends and philosophies. Nic strongly believes Asset Class Management will bring his clients Financial Freedom, Independence and Happiness.
Kirsty
Kirsty is our communication guru. Managing information requires considerable due diligence and her passion for organisation gives the clarity we all seek. From Shropshire, with a Psychology Degree and much travelling, she is now back in Shrewsbury...and London often, keeping us all at Murray Round focused.
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