How understanding your investor personality can help you make better financial decisions – Part Two

In part two of our behavioural finance campaign, we investigate three more personality traits that may be impacting you and your financial decisions, with advice on how to overcome them.

As mentioned previously, these are all taken from Finura’s investIQ test, powered by Schroders, which we encourage all our clients to take when they join us.

LOSS AVERSION

Does the pain of losing affect you more than the pleasure of winning?

Those of us with loss aversion bias tend to feel losses more sharply than the equivalent gains. This can impact our ability to make rational decisions and we end up trying to avoid losses at all costs rather than logically considering the alternatives.

When it comes to investing, loss aversion bias may lead us to hold onto falling investments for too long in fear of cashing in a loss. Similarly, we might sell rising investments too soon for fear of losing the gains.

To overcome loss aversion bias, you need to look beyond performance. If you’re thinking of selling or holding onto an investment, it’s not enough to look only at recent returns. Look at market expectations and analyse the merits and pitfalls of the investment versus alternative options. Investments by their nature rise and fall, so it’s important you don’t make decisions based on fear. Remember why you invested in the first place and any limits you set yourself, so you can form a more rational view.

A financial adviser can help guide you through any uncertainty and manage your expectations. Try a cooling off rule; take some time between making a big investment decision and carrying it out. This can provide essential breathing space for reflection and can help you make a more informed decision.

REGRET AVERSION

Are you overly influenced by your fear of making the wrong choice?

Regret aversion is the fear that your decision will turn out to be wrong in hindsight. Your anticipation of feeling regret rules the choices you make and, even when you’ve made a choice, you can still feel uncomfortable as you continue to dwell on your decision.

The worry of not getting it right can also lead you to avoid taking any action altogether. While maintaining the status quo is sometimes a viable solution, doing so purely based on the fear of getting things wrong is not a smart strategy. In your desire to avoid regret, you may be tempted to follow the crowd, even if what others are doing isn’t appropriate to your circumstances. You believe if things go wrong you’ll have less regret if others have done the same.

To deal with regret aversion, writing down all your options and their risks can provide clarity. Match them against specific criteria you’ve set for your investment objectives and, when satisfied, take action. Accept that hindsight only comes after you have made your decision, and don’t beat yourself up for not knowing everything.

Remind yourself that you made the best choice with the information you had at the time and now you’re ready to move on. You can’t change the past, but you can shape your future. Turn your regrets into a positive influence on your future behaviour. Analyse what caused your feelings of remorse and how you might do things differently next time. Then apply what you’ve learnt when facing a similar decision in the future.

AMBIGUITY AVERSION

Can you only cope with measurable risk?

Ambiguity aversion is the preference for choices where the probability of outcomes are known over those with unknown probabilities. For example, you are looking to buy a new TV and found two retailers. One retailer is cheaper, but their warranty policy is confusing. While the more expensive retailer’s warranty is clear. As a result, you buy the TV from the more expensive retailer, despite the additional cost. The cheaper retailer may well have had an adequate warranty policy, but the fact that it was unclear, led you to pick the other retailer.

In investment terms, this means you may pick what you perceive to be safer and more predictable investments that pay you a fixed amount regularly over more volatile investments with no certainty of what they will deliver, even if their return potential is higher.

Education is key to dealing with ambiguity aversion. Learn about how different types of investments perform in different market environments and don’t fill in the gaps with assumptions. An uncertain outcome does not always mean a negative outcome. Stay focused on your goals; understand that all investments will involve a degree of uncertainty, so make sure your choice is driven by what you need in order to achieve your goals within your time horizon.

Seek advice and speak to people you know who tend to have a different view to yours. It’s always useful to get a contrarian view, and they may provide a perspective that you might have missed.

To take the investIQ test, please click here.

Capital at risk; the value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Past performance is not a guide to future performance and may not be repeated.

Source: http://www.schroders.com/en/uk/private-investor/a-guide-to-investing/investiq/