Striving to be a smart investor isn't easy. All of us face a bewildering array of product choices and information sources in an ever-expanding investment universe. The financial markets are volatile and unpredictable. There's also the question of deciding which asset management and financial advisory services are best for you, and how much you should be willing to pay.
On top of these external factors, your worst enemy as an investor may very well be yourself. Your biases and beliefs. Your fears or, alternatively, your bravado.
Three panelists discussed these behavioural issues in Toronto during a panel discussion hosted recently by Morningstar Canada.
Bad things will not happen to me.
Jason Stewart, Executive Advisor, Financial Services, with consulting firm BEworks
One tendency that can hurt investors is overconfidence.
Most people believe that bad things are not going to happen to them. They won't experience either a family breakup, illness, some element of variability with respect to their employment income and the view that they can wait to engage in not only having sufficient savings but also financial planning, especially for retirement.
At the same time, investing is a daunting prospect for all but the most knowledgeable investors. Self-control and rational choice actually tax us quite a bit, even on a basic shopping purpose. Layering that on to the complexity of the financial sector, we've got a whole series of things that make it incredibly difficult for all but people who are quite numerate, have sufficient income but also sufficient training.
The greatest danger for a retail investor is panic selling during a down market.
Steve Wendel, Head of Behavioural Science for Morningstar
Getting overexcited and trying to chase fads is also harmful, but it generally pales by comparison to leaving and not being in the market when the upswing comes back.
Investors are prone to what behavioural economists refer to as "recency bias". For the everyday investor, the best predictor of what's about to happen is what has just happened. So it is a perfectly rational and thoughtful thing to say: My portfolio has just dropped 10%. I'd better get out now before it drops another 10%.
While this way of thinking would be reasonable in most situations in everyday life, it's detrimental for investors since market behaviour is fundamentally opposite to everyday behaviour.
As a result, investors as a whole experience a behavioural gap. This is a shortfall in returns which is the difference between the market returns and the returns that they experience in their own portfolios.
In fact, Bradley says the biggest issue he's faced over the past 35 years in Canada was the behaviour of many investors during the severe 2008-2009 bear market. They got out sometime in 2008 or 2009, or they got out in 2011 because they expected another severe downturn. As a result, Bradley added, Canadians as a whole "missed to a large part or were seriously underinvested in this bull market."
Disconnect between time horizons.
Tom Bradley, President and Co-founder of mutual-fund manager and direct seller Steadyhand
Another contributor to the behavioural gap is the disconnect between investors' long-term horizon and their short-term thinking about the financial markets.
The disconnect between what people's goals with their money are, and how they make decisions is just so huge, in the sense that their goals for the money are usually 20, 30 or even 40 years out, and yet their decisions are hyper-short-term.
This post initially appeared on Morningstar.ca
