Overcome Bad Investment Behaviour

4 ways to overcome bad investment behaviour

There are behavioural biases that can wreak havoc with our portfolio. The stock market is jittery over worries of an economic slowdown. A structural or cyclical slowdown, the threat of war, global issues such as Brexit or the tariff battles, the price of crude, changing interest rates – all these are events that could impact the market. And you and I can do sweet nothing about it.  Yet, those are not the only dangers. There are behavioural biases that can wreak havoc with our portfolio. Let’s turn the spotlight onto those.  Why? Simply because they are within our control, and have a high probability of affecting our decisions, which in turn has a meaningful impact on our portfolio.  Adam McCullough, an analyst on Morningstar’s manager research team in Chicago, covering passive strategies, throws clarity on this issue. The following strategies will help mitigate their effects.  1. Hit pause  Often times when making an investment decision, the benefits of waiting a day or a week to make a decision outweigh the penalty for not acting fast. Slowing down the decision-making process will allow the time to collect the necessary information to make a more informed decision. Sometimes, the best thing to do is nothing at all.  2. Keep an investment journal  Documenting your thought process leading up to an investment decision can help keep yourself in check. Use consistent sections in your journal to create a time series of decisions to find where you consistently make strong or poor decisions.  For example, you could habitually overestimate the risks of an investment decision. Knowing this information could help you adapt future decisions to incorporate this known cognitive bias. Keeping a journal can also help you keep track of skilful versus (un)lucky decisions. Did the decision pay off for the reasons that you had anticipated or because of events that you hadn’t considered?  3. Have a devil’s advocate  All human beings have a natural tendency to seek out evidence which is supportive of our previously held opinions.  A devil’s advocate is expressly charged with making the “bear case” on both current holdings and prospective investments. This will ensure that your investment thesis is challenged and vetted through an objective and sceptical lens. It will also serve to highlight any risk that may be overlooked or deemphasized.  Find a friend, financial adviser, or family member to check your investment logic and highlight your blind spots. The goal here is to help strengthen your thinking before making the decision. The best candidates for this role are those that exhibit sound logical thinking, aren’t afraid to point out when you’re wrong, and are willing to put in the time.  This is a two-way street. An investing partner will appreciate it if you exhibit the same characteristics when serving as a devil’s advocate for them.  4. Be smart with your asset allocation   Depending on your level of wealth and standard of living, emotional biases may be best managed by modifying your asset allocation. For example, you could shift toward an asset allocation that’s more conservative (for example, tilting more heavily toward bonds and away from stocks) than the risk level that you ought to be able to tolerate.  The higher your level of wealth and lower your standard of living, the more cushion you have to deviate from your optimal asset allocation. Modifying your asset allocation to adapt to your emotional biases could improve your investment outcome because you’re more likely to stick with a more conservative allocation in turbulent times.  Take it seriously  Emotional biases are more difficult to overcome than cognitive biases because it’s tough to control emotional responses to the experience of losing or making money.  Cognitive errors stem from faulty information processing or recall. These are split between two types. First is belief perseverance, which is the tendency to irrationally stick with current beliefs. These decision-making errors could stem from selective exposure, perception, or retention of new information.  Processing errors are the second type. Instead of failing to adjust to new information, these errors are caused by shortcuts that we use to make decisions quickly. Cognitive errors represent the limits of the human mind and tend to be easier to correct than emotional biases.  All investors will exhibit some of these biases at some point in their investment career. While it’s hard to avoid these biases, it’s important to take steps to mitigate their impact. If unchecked, they could torpedo your portfolio.

This article has been written by Larissa Fernand at Morningstar, an investment research firm that compiles and analyzes fund, stock and general market data. It has been sourced from the website https://www.morningstar.in and edited. You can read the original article here