By: Paul Nixon, Head of Technical Marketing and Behavioural Finance at Momentum Investments
New research reveals how easily many of us risk our hard-earned savings out of fear
Our brains are very much like a central processing unit (CPU) for the world we live in, and a pretty effective one at that. However, with the modern age having brought exponential complexity to our decision-making process, our cognitive biases – or bad mental habits – result in an actual cost over time in the form of lower investment returns.
This cost is commonly referred to as a “behaviour gap” and, for investors, is often attributed to the “switch itch”.
This is according to Paul Nixon Head of Technical Marketing and Behavioural Finance at Momentum Investments, who says that the switch itch – which refers to the urge to change investment funds – is best explained by the theory that losses are experienced roughly 2.5 times as much as the equivalent gains. “This theory suggests that investors are 2.5 times more likely to switch funds as a result of their current fund performing poorly, than as a result of another fund performing exceptionally well.”
To better understand this behaviour gap for investors, Momentum Investments set out to investigate approximately 17,600 Momentum Wealth investors from 2008 until 2018. The findings reveal that while one in four investors managed to accumulate a behaviour gap of 1% per annum (10% over 10 years); during a market crash (2008/09), this doubles to one in two investors and the behaviour gap increases to 1.1% per annum (11% over 10 years).
Nixon says that these findings provide valuable insights into when people are likely to ignore investment objectives and switch to other funds based on performance alone. “We now have proof that investors are significantly more driven by the fear of loss than they are by the prospect of equivalent gain. If, as investors, we’re aware of this tendency we can work to avoid common investment pitfalls in the future.”
When it comes to investing, Nixon says that emotions remain one of the biggest drivers of decisions and consequently of investment returns. “Depending on the market cycle and how it makes us feel, we may leave large portions of our wealth un-invested; we may be overconfident and overactive with the portion that we do invest; and, in the end, we often give in to our strong psychological tendency to buy high and sell low.”
Nixon suggests the following simple tips to help investors quell bad investment urges:
- Get advice, set goals and develop a plan to achieve these
- Have a long-term mindset and don’t worry about timing, get your wealth to work for you as soon as possible
- Diversify and spread your risk
- Have a cash windfall for a rainy day to ensure you are not forced to sell long-term investments
- Review your plan periodically and rebalance your portfolio as required
For Momentum Investments, this study is the first step of many in uncovering and discovering the causes of these investment missteps that place people’s investment goals in jeopardy. “Understanding their motives and triggers better will help us manage and close this behaviour gap. Ultimately, it comes down to helping people to avoid that switch itch and remaining committed to the broad, yet powerful, investment principles that we know are proven to work and deliver over the long term,” Nixon concludes.