There is a risk that we behave like Stone Age hunters rather than investors. Moira O'Neill explains how to avoid this common problem and achieve better results.
To be a successful investor, you must buy low and sell high. Unfortunately, most people allow their emotions to get the better of them and instead, they buy high and sell low.
Why do we do this? Behavioural finance experts, such as billionaire investor Ken Fisher, chief executive of Fisher Investments, take us back to the Stone Age, when the battle for survival programmed humans to hate losses more than they love gains.
Stone Age hunters had to exert more effort to avoid pain (broken leg = inability to defend or feed family for two months) than to make a gain (kill gazelle). But it also paid to take big risks – one big kill could mean a month's protein for the tribe. Our ingrained survival instincts urge us to take risks – we frequently choose ‘fight’ over ‘flight’ when facing insurmountable odds. Investors, by definition, are overconfident when assuming they know more than they do or when overestimating their skill level.
We are also influenced by what behaviouralists term 'regret shunning' and 'pride accumulation'. If the hunters didn't accumulate pride and shun regret, they would have become despondent over failure. They would have given up hunting giant beasts as a fool's errand.
Stone Age hunter = It is my particular skill with the spear that led me to kill the gazelle.
Investor = I bought shares in Apple in 2002 after my 12-year-old asked for an iPod. I’m an investment genius.
Stone Age hunter = I had some bad luck today because lions frightened the gazelles away. It’s not my fault.
Investor = I bought an investment today and its price fell. I had a row with my wife this morning, so I wasn’t concentrating properly.
So what's the solution?
Most investors, and particularly beginners, will find that they get better results and more peace of mind by drip-feeding their money on a regular monthly basis into the stockmarket. This means their investments will also benefit from 'pound-cost averaging', which allows you to buy units more cheaply on average. By investing the same amount at regular intervals more shares are purchased when share prices are low and fewer shares are purchased when prices are high.
Investors further down the line will find it beneficial to regularly rebalance their portfolios. This creates a discipline of selling some of your winners to buy more of your investments that haven't performed so well. It will make sure that your portfolio doesn't become too skewed towards the investments that have outperformed. You should think about doing this at least once, and preferably twice a year.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
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