In our recent article we discussed how market volatility can actually present opportunities for investors yet, when we hear the word volatility, as humans, our natural reaction may be to err on the side of caution.
At Finura, one of our core approaches to financial planning is to use behavioural finance techniques to help our clients uncover the drivers behind their financial decision making. Through identifying these biases or tendencies, together, we can use this insight to develop a solution that puts analysis ahead of instinct and that fits with you as an individual.
In our next series of articles, we will cover the different behaviours that may be impacting you and your financial decisions. These are all taken from Finura’s investIQ test, powered by Schroders, which we encourage all our clients to take when they join us.
Are you influenced by thoughts and actions of others?
As humans we can be influenced by the thoughts and behaviours of those around us; leading us to assume that those around us collectively know something we do not. As a result, we irrationally follow others, ignoring the information we have and what’s right for us as an individual.
To overcome herd bias when making financial decisions, it’s important to be realistic about your current financial situation and to assess it with a clear head. Start by identifying your financial goals, the amount of risk you are willing to take and over what timescale.
Just because the herd is following a particular trend, it does not necessarily mean it’s the right thing to do. Before investing, it’s vital to ask yourself what is driving the herd’s behaviour? What might they have missed? And what other opportunities are available?
If a trend has been followed by many people for some time, it may no longer represent a good investment opportunity; speaking to your financial adviser will help to reveal whether or not following the crowd is in fact a wise thing to do.
Not as good as you think you are?
Over confidence is the tendency to believe in yourself without considering factors beyond your control. This may lead you to overestimate your ability to make rational investment decisions. As a result, you might think that investment markets cannot surprise you or you might take on more risk than is necessary and move investments around too frequently.
To tackle overconfidence, the advice is to be pragmatic. Previous outcomes should have little bearing on future decisions. Don’t believe your previous investment successes will automatically lead to further success. Instead, ensure you evaluate every investment thoroughly before making a decision.
A logical step is to seek professional advice, as an adviser will be able to provide you with realistic expectations of success and, importantly, the potential risks. Most investments are designed to be held for the long term so there should be no need to change them without good reason. Furthermore, moving in and out of investments incurs transactional costs which can have a significant impact on your returns if done too frequently.
Do you overestimate the chances of success and underestimate the risks?
Over optimism is the tendency to overestimate the likelihood of success without focusing on any potential pitfalls. In investment terms, you might be too focused on the positive potential outcomes and not realistically considering the possibility of incurring losses. As a result, you may take on more risk than you can sustain.
To stop over optimism clouding your decisions, it’s important do your homework. Keep in mind that investments can go down as well as up. Ensure you have a full understanding of the investment you’re considering and how it could be impacted in differing market environments.
We always hope for the best from our investments, but things may not always work out as planned so taking precautions is necessary.
Diversification is one such precaution you can take and central to any sound investment strategy; while it does not guarantee against losses, spreading your money across a variety of different investments can limit the impact of any bumps in the road. A financial adviser can help you build a diversified portfolio that suits you.
To take the investIQ test, please click here.
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