How you can make better investment decisions
There is a concept known as behavioural finance which governs the way you make investment decisions. It’s really the combination of economics, psychology and sociology which provides explanations for why people make irrational investment decisions.
Fortunately, there is an acronym which helps you to understand your biases, what they are and how they affect you. It is called MIRRORS.
M Myopic loss aversion
R Recent events
R Risk perception
So let me explain each one.
Myopic loss aversion
We are more sensitive to losses than gains and overly influenced by short-term considerations.
We seek to conform to group behaviour and prevailing norms.
We overemphasise the importance of recent events.
We are poor at assessing risks and gauging probabilities.
We overestimate our own abilities.
We focus on outcomes, the results of our decisions, when assessing their quality.
We are often persuaded by captivating stories.
In order to improve your investment decision making, you should review the above list and score yourself to decide whether or not you are making the same mistakes as most other investors.
The most common adverse investor behaviours are listed below:
- Not saving enough to reach your stated goals;
- Expecting future returns to be as good as in the past;
- Having unrealistic expectations;
- Tracking investments too frequently;
- Needing reassurance whenever there is a big news item on markets;
- Buying expensive investments because they just did really well in the past;
- Unwilling to sell high performing investments (when their prospects start to dim);
- Unwilling to buy (any) investments when markets have had a big sell-off;
- Wanting to sell underperforming/cheap investments with good prospects.
Six tips for better investment decision making:
- Do write up a long-term investment plan;
- Do automate savings plans;
- Do rebalance portfolios;
- Don’t check investments too frequently;
- Don’t make emotional decisions;
- Don’t trade! Make doing nothing the default.
So if you would like to make better investment decisions in the future do contact us for further advice. You know it makes sense.