Understanding how the mind can help or hinder investment success is a topic seldom considered by an investor. At FFP we believe it is an essential part of investment planning.
Behavioural Finance is the study of the psychology of financial decision-making. Over the last 20-30 years there has been groundbreaking research which, sadly, does not appear to make headline news.
Behavioural Finance suggests investors are overconfident with respect to making gains and oversensitive to losses. In plain terms, most of us think that we are significantly better than average as, for example, drivers. Very few people consider themselves to be a poor driver, whereas in reality 50% of us by definition must be worse than average.
This also relates to investing - all too often the response to a poor period of fund performance is to sell and buy into a fund which has performed better and is, therefore, more expensive. Research suggests that this action - far from helping improve returns - will cut the expected return by half. It is a bit like changing lanes in a motorway traffic jam - it seems appealing but rarely does it improve your journey time!
When investments are increasing in value we tend to become overconfident, we begin to expect that investments will always go up. Conversely, when investments are falling we tend to overreact and sometimes panic. Research tells us that most investments are purchased in a rising market and very few when markets are falling. Yet, if we were shopping we wouldn't wait until prices went up! We love a sign that says "30% off" - except when it comes to investing.
Source: Carl Richards (Behaviour Gap, 2018)
FFP understands how powerful emotions can be and helps its clients to be patient and disciplined, as well as to avoid common mistakes.