Skipton Financial Services
Friday, March 29, 2019 - 10:01

Seven ways to keep a rational investment mind-set

Investing in the stock market can be very rewarding over the long-term. However, as share prices suffer periods of fluctuation, there’s always a risk of losing money. Falling markets can be worrisome, and as emotions take over it may be tempting to suddenly withdraw any investments you have. But, maintaining a long-term perspective can make periods of uncertainty easier to handle.

It’s understandable that staying positive during unsettling periods is easier said than done, so we’ve spoken to Joe Wiggins, Aberdeen Standard fund manager, who’s provided us with his seven tips for keeping a rational mind-set over the long-term.

1. Focus on the long-term

Understanding and controlling our own behaviour is probably the biggest challenge investors’ face.

I tend to think about the main obstacles to sensible long-term investment in two distinct areas – bias and noise. Behavioural biases are instances where our choices tend to consistently deviate from what might be considered rational. For example, we tend to be more sensitive to losses than gains.

Noise is where our judgements are influenced by irrelevant factors, causing us to make inconsistent or erratic decisions. This is a particular problem for financial markets, as there’s so much information and news out there, much of it not relevant to our long-term goals.

2. Avoid the urge to panic

Short-term stock market fluctuations are an inevitable feature of most long-term investments, particularly stock markets.

One of the main issues with investors is they can pay too much attention to short-term movements, and react to them. These movements in asset prices are inherently unpredictable, and therefore it is very dangerous and often damaging to react to these.

It’s important to remember that one of the reasons that stock markets have historically delivered high returns is as a compensation for the price fluctuations that they suffer.

3. Don’t follow the herd

Joining the herd can be irresistible. It can be hard to ignore the allure of an investment that is enjoying a rapid price ascent, particularly if many other people are participating in it. It can also prove hard to stick with your long-term investment plan when others are selling en masse.

There’s no easy remedy to this, aside from focusing on your own objectives, having a clear plan, a sensibly diversified portfolio and a long-term horizon.

4. Ignore the urge to constantly check your investments

I think the best step that most individuals can take is to check their portfolio less frequently. Studies have shown that the more regularly we look at our portfolios, the more often we trade and the more risk averse we become.

If we start out with a clear investment plan and a sensibly diversified portfolio, that is suitable for our risk tolerance, there really is no need to check its value every day, week or month.

I would argue that by resisting the urge to constantly check our portfolio it makes it far less likely we will succumb to some of our behavioural weaknesses.

5. Maintain a balanced perspective with gains and losses

People tend to be loss averse – that is we feel losses more than gains of equal value. This is a real behavioural problem for long-term investors, as we often worry too much about the short-term fluctuations of markets and make poor decisions because of this.

Having a diversified investment portfolio is an important defence against this – therefore if one element is weak the other might be delivering. This goes hand-in-hand with having a long time horizon – if you own a sensibly structured portfolio, then taking a long-term approach increases the probability that you will generate returns.

Returning to how frequently you monitor your portfolio, this is a crucial element. If you have a 30 year investment horizon but check your valuation each day you will experience the tribulations of frequent gains and losses, this is emotionally draining and can lead to poor investment decisions led by our aversion to short-term loss.

6. Postpone decisions driven by emotion

If it is possible that our emotions are influencing our investment decisions, we should be worried. Fear and greed are incredibly influential on the choices we make.

A simple rule is that if we have any sense that an investment decision is being driven by emotion, postpone it. If it was a good decision today, it is still likely to be one tomorrow, but any emotions we were feeling might have cooled.

7. Be sure you’re making rational decisions

It is very difficult to be the arbiter of your own investment decisions – at the time you are making a choice it will typically feel incredibly rational, and it is only with hindsight that you may realise where you have erred.

It is certainly useful to ask yourself certain questions before making an investment decision:

  • Am I reacting to short-term losses?
  • Am I following the crowd in a flavour of the month trade?
  • Am I being overly influenced by recent news?

The best approach an investor can take is to reduce the amount of decisions they have to make, by having a prudent long-term investment plan and sticking with it.

The above views are those expressed by Joe Wiggins and should not be construed as financial advice. If you do have concerns about your investments Skipton has financial advisers who will be able to discuss matters with you.  

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