How to avoid behavioural investment traps

Many people don’t realise the greatest impact on their investment returns could in fact be their own behaviour. Here are four behavioural traps you should be aware of.

1. Making decisions during market volatility

When you see markets up one day and down the next, it’s easy to be nervous about investing, and this is when we risk making irrational decisions. It’s important to remember that market volatility is inevitable, while markets tend to bounce back over the long term. While there may be good reasons to sell, you should also remember that by selling out if you’re nervous, when markets are low, you may only crystallise losses.

One suggestion is to stay focused on your long-term goals and try to ignore market ‘noise’.

2. Becoming overconfident in strong markets

Many decisions people make during strong markets will likely come right, because the entire market is rising. This will make many people feel smart and more confident in their ability to invest. It’s important to remember that returns from rising markets aren’t an indicator of investment skills. It’s how people behave and how their investments perform during times of market distress that are the sign of a good investor.

3. Avoiding herd mentality

It’s a natural human tendency to position ourselves relative to others and to feel the need to ‘keep up’. However this can lead to poor financial decisions. New investment trends can easily get traction and create conversations amongst friends and family. The dotcom bubble is a perfect example as share prices of many internet companies soared, encouraging investors to get in.

By early 2000, markets began to crash and investors suffered. While it’s tempting to take part in the latest trend, it’s important to take the time to assess any investment on its own merit and whether it suits your personal goals.

4. Being swayed by recent events

We are wired to give undue weight to the most recent events. This is especially true when investing. In 2010, with the GFC fresh in the minds of many, the common view was that Australian shares could do no wrong and international shares were shunned.

But then, in the five years that followed, international shares provided far better returns than Australian shares1.

This meant that investors who had sold out of international shares missed the rally. Instead of chasing yesterday’s winners, it’s usually best to remain patient and stick to your personal plan. We often go to considerable efforts to maintain the belief that we’re in control of situations where we really aren’t. It’s the same for investments: no one truly knows what lies ahead for markets.

Source: NAB Asset Management

Speak with Wynyard Park Private Wealth to discuss your investment options.

1 Unhedged international shares returned eight per cent per year more than Australian shares, over a five year period from 1/10/10 – 30/09/15. Based on MSCI All Country World Index and ASX/S&P 200 Accumulation Index.