RP: Hello there. The investor’s worst enemy, it’s been said, is likely to be himself. Regardless of whether they invest actively or passively, investors often harm their portfolios through the way they behave. Behavioural coaching is an important role of a financial adviser. But is there anything investors can do to protect themselves from their own emotional biases?
Well, behavioural finance expert Tim Richards says one thing you can do is to write down your reasoning every time you make an investment decision and, every year or so, to record the returns you achieve.
TR: Most investors don’t know how much they make. They don’t actually measure how much they actually return and they don’t have anything to compare with against what market returns might be. So how on earth can they figure out whether they’re a good investor or not?
RP: Another problem is that people often choose to rewrite the past — usually to protect their emotions. Investors do it all the time.
TR: They will ignore things that have gone wrong, or they’ll put them in a separate port, which is a thing called mental accounting. So it’s not actually part of their main port that loss was somewhere else they don’t have to worry about that. And they suffer from hindsight bias. So hindsight bias is massive. The CIA called hindsight bias ineradicable. They spend a lot of time obviously with their operatives trying to figure out what’s actually happened. If it’s not written down at the time, people can’t remember. Everything they think they remember is biased by whatever’s happened since.
RP: Investors often come unstuck during or after a market correction or crash, or when markets are particularly volatile. So what can you do at times like that to help yourself stay the course?
TR: There are no known ways of actually preventing people being scared of this stuff. Fear, uncertainty, and doubt reigns throughout the markets. The only thing in this area that really works is having an understanding of history. So having a basic understanding of what’s happened in financial markets over longs periods of time. I mean we’re not talking over, you know, two or three years. We’re talking over twenty, thirty, forty even a hundred years. Is really the only thing that can actually give people the comfort to stay the course of time.
RP: Finally, what’s the one piece of advice that Tim Richards would give to investors on managing their behaviour?
TR: The best thing you can do, with any investing fund is, don’t look at the value of it. Don’t. Essentially anybody who looks at what they’re doing more than once a year is probably looking at their funds too often.
RP: That was Tim Richards. If you found his tips helpful, you might want to follow his blog. It’s called The Psy-Fi Blog and you can find it at psyfitec.com.