Our brains are very much like a central processing unit (CPU) for the world we live in, and a pretty effective one at that. However, with the modern age having brought exponential complexity to our decision-making process, our cognitive biases \u2013 or bad mental habits \u2013 result in an actual cost over time in the form of lower investment returns.<\/p>\r\n\r\n\r\n\r\n
This cost is commonly referred to as a \u201cbehavior gap\u201d and, for investors, is often attributed to the \u201cswitch itch\u201d. This is according to Paul Nixon, Head of Technical Marketing and Behavioural Finance at Momentum Investments, who says that the switch itch \u2013 which refers to the urge to change investment funds \u2013 is best explained by the theory that losses are experienced roughly 2,5 times as much as the equivalent gains. \u201cThis theory suggests that investors are 2,5 times more likely to switch funds as a result of their current fund performing poorly, than as a result of another fund performing exceptionally well.\u201d<\/p>\r\n\r\n\r\n\r\n
To better understand this behavior gap for investors, Momentum Investments set out to investigate approximately 17,600 Momentum Wealth investors from 2008 until 2018. The findings reveal that while one in four investors managed to accumulate a behavior gap of 1% per annum (10% over 10 years); during a market crash (2008\/09), this doubles to one in two investors and the behavior gap increases to 1,1% per annum (11% over 10 years).<\/p>\r\n\r\n\r\n\r\n
Nixon says that these findings provide valuable insights into when people are likely to ignore investment objectives and switch to other funds based on performance alone. \u201cWe now have proof that investors are significantly more driven by the fear of loss than they are by the prospect of equivalent gain. If, as investors, we\u2019re aware of this tendency we can work to avoid common investment pitfalls in the future.\u201d When it comes to investing, Nixon says that emotions remain one of the biggest drivers of decisions and consequently of investment returns.<\/p>\r\n\r\n\r\n\r\n
\u201cDepending on the market cycle and how it makes us feel, we may leave large portions of our wealth un-invested; we may be overconfident and overactive with the portion that we do invest; and in the end, we often give in to our strong psychological tendency to buy high and sell low.\u201d Nixon suggests the following simple tips to help investors quell bad investment urges:<\/p>\r\n\r\n\r\n\r\n
1. Get advice, set goals and develop a plan to achieve these<\/p>\r\n\r\n\r\n\r\n
2. Have a long-term mindset and don\u2019t worry about timing, get your wealth to work for you as soon as possible<\/p>\r\n\r\n\r\n\r\n
3. Diversify and spread your risk<\/p>\r\n\r\n\r\n\r\n
4. Have a cash windfall for a rainy day to ensure you are not forced to sell long-term investments<\/p>\r\n\r\n\r\n\r\n
5. Review your plan periodically and rebalance your portfolio as required.<\/p>\r\n\r\n\r\n\r\n
For Momentum Investments, this study is the first step of many in uncovering and discovering the causes of these investment missteps that place people\u2019s investment goals in jeopardy. \u201cUnderstanding their motives and triggers better will help us manage and close this behavior gap. Ultimately, it comes down to helping people to avoid that switch itch and remaining committed to the broad, yet powerful, investment principles that we know are proven to work and deliver over the long term,\u201d Nixon concludes.<\/p>\r\n\r\n\r\n\r\n