From crippling businesses to sending us stir-crazy, lockdowns already have a lot to answer for. But there’s another charge to lay at their door: they could be making us worse investors. The best investment decisions are made when we’re cool and collected and able to follow a strategy. Yet the pandemic and lockdowns are sending us off course, making many of us more erratic.
That’s because when under stress we tend to make short-term decisions and are guided by our emotions rather than reason. Compound this with the claustrophobia of lockdown and it’s a recipe for disaster.
‘Investors are being guided by emotion more than ordinarily,’ says Dr Ben Kelly, a senior analyst in Columbia Threadneedle’s global research team. ‘We’re living under a lot of stress due to the pandemic. This is hard, but even more so in lockdown. When people are stressed we need outlets to vent our frustrations. Closed environments make that more challenging.’
Keep a cool head: Investors need to make a plan and stick to it – rather than be swayed by their emotions
So if you find you’re prone to panicking over whether to sell your investments or are watching markets swing and wondering whether you should join in the furore, you are not alone.
But don’t worry, there is an area of investing theory dedicated to helping investors rein in emotions and make sound decisions. Behavioural investing is a growing discipline – and has plenty of practical applications for us ordinary investors.
Take a deep breath…and try to imagine the future
According to Bertie Thomson, manager of investment fund Brown Advisory Global Leaders, short-term thinking in stressful situations is part of human nature – an instinct that has helped the human race to survive.
‘We cannot think long term when we’re under stress,’ says Thomson. ‘That is because we have long-running evolutionary behaviours learned over thousands of years to help us survive.
‘For example, fighting a lion in the savannah, you need to be in that moment. But the same instincts mean that in March and April this year, investors could not think beyond that time.’
Pushing your time horizons further into the future is key to good long-term decision making.
Alasdair McKinnon, manager of Scottish Investment Trust, strives to do just that. ‘Everything we know now we could have known in March,’ he says. ‘Although we couldn’t know how lethal the virus would be or when we would get a vaccine, we had an idea how it would play out. Still, investors wait for the share price to confirm it.’
McKinnon strives to look past the mayhem to seek future winners. He focuses on buying ‘ugly ducklings’ – companies unloved by investors because of short-term issues that he believes will reward long-term investors by transforming into swans.
He likes banks, retailers and oil companies. McKinnon sold holdings in February that he believed would be hit by the pandemic, but is now starting to ‘nibble’ back in.
Challenge your own view of the world
Threadneedle’s Kelly is amazed at just how many experts in virology there are in the UK. He says: ‘Last December, I had barely heard of virology. By March, nearly everyone seemed to be an expert in it, including my mother who had a career at Chanel.’ He believes we have been exposed to an extraordinary amount of information, updates and views – all of which can be distracting noise for investors.
‘Once you have a view, it’s hard to get rid of it,’ says Kelly. ‘After it is formed, we tend to only seek out what fits our view of the world This may or may not be right, but if we’re not continually challenging it, long term it can be destructive.’ In behavioural investing, this phenomenon is known as confirmation bias – latching on to and then continually validating one particular view. To counter it, Kelly recommends investors challenge themselves to seek information that disproves their views.
Both Kelly and Thomson also recommend carrying out a so-called ‘pre-mortum’ before you buy an investment.
Kelly explains: ‘Before you buy something, imagine that six months later it has failed.
‘Think about the reasons why this could have been the case. This process can draw out some of the risks you hadn’t necessarily considered. It’s a useful way to challenge your decision-making.’
Be wary of crowds…a majority can be wrong
Following the herd is a human instinct. ‘We are all tribal creatures,’ says McKinnon.
‘Up until not that long ago, if you shunned the tribe, you wouldn’t survive very long.’
But the majority don’t always get it right. People can become fearful or greedy, and investing bubbles can form. Writing down a plan can make it easier to go against the crowd. You will be able to refer back to your rationale and reduce the temptation to act on impulse.
Kelly believes one reason investors follow the crowd is to avoid failing on their own. Making the wrong call hurts, but it stings even more when others are winning. ‘Regret is a really dark place for investors,’ he says. ‘People are more comfortable sticking with the crowd to avoid the feeling of regret.
Regret targets the same part of the brain as being punched in the face,’ he adds. ‘There is no physical impact, but you feel beaten up.’
Kelly has spoken to investors who have seen ten years of growth in equities and have thought it could be a good opportunity to bank those gains and move partly into bonds, which tend to be lower risk.
However, even though rationally they believe this makes sense, they don’t do it because they couldn’t bear to watch if equities continued to rise and they missed out. To overcome the fear of regret, he recommends ‘focussing on the process rather than the outcome’. Kelly also suggests keeping an investment diary of why you made decisions that you can refer back to later.
Loss is hard…but learn to let go
As the world is shaped and scarred by the pandemic, many companies and sectors are likely to lose out indefinitely. Investors have difficult decisions to make about when to cut their losses and move on.
However, we’re inherently bad at dealing with losses. Behavioural investing tells us that a loss causes us more pain than a gain gives us pleasure – so we tend to avoid facing up to losses at all costs. Thomson explains: ‘If we sell, we crystallise a loss. We expose ourselves to the pain of regret. That is why if we don’t have a rule to deal with losses we can become a big loser.’
Thomson himself has a rule that if a company his fund invests in falls in value by 20 per cent or underperforms by 20 per cent over one year, they carry out a full review. At that point, they either sell it or buy more. Having a strategy takes the emotion out of the equation for the investment team.
Learn your failings…and avoid slip-ups
Taking the emotion out of investing is all but impossible. While traditional economic theory likes to imagine we are all rational beings driven solely to maximise profit, the fact is we are human, with foibles, emotions and prone to erratic behaviour when under stress. The key is to be aware of our traits and weaknesses and to put a plan into place so they do not derail us.
Thomson and his team have been behavioural investing experts for years, but they still see a behavioural coach every week to identify biases. Nick Kirrage, a fund manager with Schroders, agrees that no matter how much theory you have absorbed, you can still slip up. He says: ‘Build a process that allows you to stand above yourself and stops you being led by a gut response.’
Kelly suggests writing a list of questions to ask yourself regularly. For example: ‘Have I challenged where I could be wrong?’ ‘Am I holding losing stocks simply in the hope they will revert to the mean?’ ‘Am I using irrelevant information to influence my decisions?’ Finally, don’t dismiss your instincts. For example, if an investment sounds too good to be true, it probably is.
