Market volatility in the wake of the recent spate of natural disasters around the world is causing many investors to reassess their offshore investments. However, investors are urged not to make emotional investment decisions that could negatively affect their long-term investment goals.
When it comes to investing, one of the most destructive, yet least talked-about forces, is the power of emotion and the devastating effect is has on the ability of investors to make sound investment decisions based on logic and reason.
Emotion causes investors to panic during market dips or local economy shocks, become greedy when markets rise, follow herd behaviour, become irrationally attached to their investments, switch too often between funds and take on too much or too little risk. This behaviour has the ability to have a significantly negative impact on investment returns.
A good example of the destructive power of emotional investment decision making can be found in the recently updated Dalbar Study into investor behaviour. The study found that over the 20 year period ending December 31, 2009, the average equity investor earned 3,17 percent per year, while the S&P 500 index returned 8,2 percent annually. These miserable results are attributable to investors buying stocks during manias and selling them during panics.
South African investors are equally guilty of this type of behaviour. In the post-collapse environment in the first half of 2009, many investors were gripped with fear, leading to irrational sell-offs of equities.
Statistics by ASISA showed that many investors increased their exposure to equities in the months running up to the global financial crisis, then shifted their assets into money market funds after the worst of the financial crisis had passed and the equity market had bottomed.
Quarterly statistics published by the Association for Savings and Investment South Africa (ASISA) revealed that domestic equity funds attracted R4,8-billion of net inflows in the second quarter of 2009, mainly from institutional investors. Individual investors continued to place their money mainly with money market funds, which attracted net inflows of R14,8-billion in the second quarter of 2009. In the second quarter alone, the JSE Alsi gained 8,3% and by the middle of July 2009 gained a massive 30,1% from its March lows.
Understanding and acknowledging your emotions and the influence they have on your investment behaviour is the first step to controlling them. Investors with certain personality types, such as confident alpha males, are often more prone to making emotional investment decisions. Unfortunately, these are often the very people who are least likely to acknowledge that that they are predisposed to doing so.
One of the ways investors can help to make decisions based on reason rather than emotion is to identify a trusted financial advisor who can help guide them through the process. There are a few other basic steps investors should follow to ensure they keep emotions as far from their investment decisions as possible:
· Understand their investment goals and stick to them
· Have realistic expectations about what they can achieve
· Set realistic time frames
· Have a clear philosophy and framework and remain consistent
· Avoid short-term speculation and betting
· Focus on long-term investing goals
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