Investors should ignore manias and panics

Market volatility in the wake of natural disasters around the world has caused a lot of investors to reassess their offshore investments. But should they rush into a decision, based on emotion, which might negatively affect their long-term investment goals?

We know that emotion causes investors to panic during market dips or local economy shocks—they also become greedy when markets rise, adopt herd behaviour, become irrationally attached to their investments, switch too often between funds or take on too much (or too little) risk.

“This kind of behaviour can have a significantly negative impact on investment returns,” says Rob Macdonald, head of consulting and institutional business at Nedgroup Investments.

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 31 December 2010, the average equity investor earned 3,83% a year, while the S&P 500 index returned 9,14% annually.

Although this year’s study found that the average equity investor had increased retention rates from 3,22 years in 2009 to 3,27 years in 2010, this still falls far short of the optimum needed to take advantage of market performance, the report said.

These miserable results can be attributed to investors buying stocks during manias and selling them during panics.

How to invest using reason
Macdonald says 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.

Understanding and acknowledging your emotions and the influence they have on your investment behaviour is the first step to controlling them, says Macdonald.

“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.”

He says 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.

According to Macdonald, there are a few other basic steps investors should follow to ensure they keep emotions as far from their investment decisions as possible:

  • Understand your investment goals and stick to them.
  • Have realistic expectations about what you 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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