April 21, 2024
Robin Powell

Don’t be Seduced by Trendy Investments

Most of us have been tempted by the latest investment fad, and many of us have succumbed. I certainly have. Before discovering evidence-based investing, I often read the money sections of Sunday newspapers in search of new ideas, and on the odd occasions where I was persuaded to invest it rarely turned out well. 

Perhaps my biggest investment regret was buying a technology fund in the late 1990s. It seemed a logical thing to do at the time. After all, the internet was starting to change our lives dramatically. Yet I, along with many other investors, lost money in the dotcom crash. 

There are plenty of similar ideas around today — artificial intelligence, plant-based meat alternatives and driverless cars, for example. You could make a strong case for investing in any of those things. Other investment ideas are billed as diversifiers, with risks that aren’t correlated with those of equities, but which offer the potential for higher returns than cash or bonds.  

However, it’s vitally important, when you read about new investment “opportunities”, to slow down and look at the bigger picture before investing your hard-earned money. 

Why we’re drawn to themes and trends 

The attraction of trendy investments is deeply ingrained in us. It’s largely down to how the human brain has evolved over hundreds of thousands of years. 

We tend to look for patterns, for example, even where none exists. We’re also highly influenced by what those around us are doing; for instance, if someone you know has made a small killing on a particular investment, we’re far more likely to invest ourselves. 

But there are two reasons in particular why investors find the latest investing fads so appealing. 

1. We tend to be overconfident 

Human beings are prone to overconfidence. It’s a trait that helped our ancestors secure resources, mates and social standing. But it can land us in serious trouble in activities like investing.  

Investors often make the mistake of assuming that they’re relatively sophisticated. They think they’re smarter than they really are. But the financial markets, and the combination of factors that cause them to move up and down, are much more complex than people realise. The evidence suggests that most investors lack even the most basic knowledge of different investments.  

In February 2024, Morningstar published a report called Investor Interest in Trendy Asset Classes. As part of the research, investors were asked about trends such as commodities, cryptocurrencies, private equity and private credit. For most of the assets included in the survey, fewer than half of respondents felt they could even pick out the correct definition from a list.  

Investors were then asked about their motivations for making changes to their future investments in each of those assets. The most common reasons people gave were the desire for better returns, their belief in the long-term viability of the asset, macroeconomic factors they thought could affect the asset, and wanting to time the market. 

In other words, investors overwhelmingly showed classic signs of overconfidence. 

2. We’re suckers for good stories 

The second behavioural bias that significantly contributes to investors’ interest in trends and themes is called narrative bias. Humans have always communicated through storytelling. Why? Because stories are very powerful. They can influence beliefs, attitudes, and behaviours in profound ways. 

Investors will often investigate investing in something because they’re read about it in the media or in an article distributed by an online broker or investment platform. The reasons for investing often seem very compelling, and people feel emboldened to invest on the strength of them. The growth of social media and the popularity of smartphones have only exacerbated this tendency for investors to rely on narratives.  

It must be said, there are some excellent financial journalists, and there is plenty of useful information for investors online. The problem is that the content that is genuinely helpful and free from bias is buried inside a tsunami of noise and opinions that really don’t matter.  

You should also bear in mind that even if the narrative turns out to be right, you could still lose money. The dotcom crash was one of many examples throughout financial history of seemingly good ideas that made for bad investments. 

How to stay rational 

So, what can you do to reduce the risk of investing in a trendy theme or asset class and later regretting it? Here are some suggestions: 

1. Sleep on it 

When we’re excited about investing in something, the temptation is to act straight away, but it’s a very bad idea. Consciously take some time to think, research your options carefully and ensure you aren’t being influenced by unhelpful cognitive biases. At the very least, sleep on it. 

2. Acknowledge your limitations 

Don’t assume you’re a better-than-average investor. Remember, the financial markets are highly efficient and ruthlessly competitive. For every buyer there’s a seller, and vice versa. Always ask yourself: Who is the person on the other side of the trade you are thinking of making? The chances are that it’s a professional investor with far more knowledge and skill than you. 

3. Guard against confirmation bias 

Don’t just diversify your portfolio — diversify the sources of information you refer to when making an investment decision. Beware, financial journalists like to read about trendy investment because they come with a ready-made narrative. So think about why journalists and other commentators write and say the things they do. Separate news from opinion. Ask yourself whether a certain piece of information is anything more than noise. And actively seek out information that conflicts with any opinions you may have formed. 

4. Ask what’s motivating you 

If you’re tempted to invest in something, examine your motivations and whether or not they’re valid. For example, are you choosing to invest in something just because it’s easy to or because a new product or trading app has just been launched? Are you worried about missing out on stellar returns? Or, let’s be frank, do you just want a bit of a gamble? 

5. Have a long-term plan 

Before making an important investment decision, you should always seek professional advice. If you don’t understand a particular investment, ask an adviser to explain it to you and to set out the pros and cons. Crucially, if you don’t already have one, get yourself a financial plan and an investment strategy designed to achieve your goals. Having a clear, long-term plan will make these sorts of investment decisions very much easier. 

Tips to avoid being fooled by misinformation

There is more information at our disposal than ever before. Now you may have thought that would be a positive thing, but it’s harder than ever to discern its quality, reliability and significance.

May 22, 2024