How to avoid investment behavioural traps

Here are four common behavioural traps you should be aware of.

1. Making decisions during market volatility

When you see markets up one day and down the next, it’s easy to be nervous about investing, and this is when there is a risk of making irrational decisions. It’s important to remember that market volatility is inevitable, but that markets tend to bounce back over the long term. While there may be good reasons to sell, you should also remember that by selling out if you’re nervous, when markets are low, may only crystallise losses. One suggestion is to stay focussed on your long-term goals and try to ignore market “noise”.

2. Becoming overconfident in strong markets

Many decisions people make during strong markets will likely come right, because the entire market is rising. This will make many feel smart and more confident about their ability to invest. It’s important to remember that returns from rising markets aren’t an indicator of investment skills. It’s how people behave and how their investments perform during times of market distress that are the sign of a good investor.

3. Avoiding herd mentality

It’s a natural human tendency to position yourself relative to others and to feel the need to “keep up”. However this can lead to financially poor decisions. New investment trends can easily get traction and create conversations amongst friends and family. The dotcom bubble is a perfect example: share prices for many internet companies soared, encouraging investors to get in. By early 2000 markets began to crash and investors suffered. While it’s tempting to take part in the latest trend, it’s important to take the time to assess any investment on its own merit, and against your personal goals.

4. Being swayed by recent events

People are wired to give undue weight to the most recent events. This is especially true when investing. With the GFC fresh in the minds of many, in 2010 the common view was that Australian shares could do no wrong and global shares were shunned. But then, in the five years that followed, global shares provided far better returns than Australian shares². This meant that investors who had sold out of global shares missed the rally. Instead of chasing yesterday’s winners, it’s usually best to remain patient and stick to your personal plan.

While people often go to considerable efforts to maintain the belief that they’re in control of situations where they really aren’t. It’s the same for investments: no one truly knows what lies ahead for markets.

Speak to your financial adviser to discuss your investment options.

2. Unhedged global shares returned 8% pa more than Australian shares, over a five year period from 1/10/10 – 30/09/15. Based on MSCI All Country World Index and ASX/S&P 200 Accumulation Index. Source: NAB Asset Management. Past performance is not a reliable indicator of future performance.

Source: MLC