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Investment: Beware of these two human tendencies

May 19 2019 11:02

The scientifically studied human tendencies of loss aversion and recency bias are often evident in how people approach investing, according to Anet Ahern, CEO of PSG Asset Management.

Loss aversion is a strong preference for avoiding a loss over making an equivalent gain.

Recency bias is the tendency to attach more significance to recent events than to events in the past.

"Given our loss aversion and recency biases, it's easy to understand that heightened uncertainty and disappointing investment returns may have tempted investors to switch out of investments that have recently performed poorly, or to exit the market completely," explains Ahern.

"However, staying the course improves the odds of favourable long-term investment outcomes. Research has shown that most investors are notoriously bad at market timing."

By selling when prices are low, investors may lock in losses, especially if they only re-enter the market once prices have already started climbing.

"We often note that the best opportunities are found in times of fear and uncertainty. Moments of panic invariably result in the prices of quality companies and securities falling along with the rest of the market," she adds.

Ahern points out that last year marked the worst year since the global financial crisis for the JSE All-share Index. The overall index was down in rand terms year-on-year (y/y).

"Even more discouraging was that this signified one of the worst five-year periods the local market had seen in decades, deepening investor disillusionment," she comments.

"Although the local market recovered somewhat in the first quarter of 2019 - driven largely by rand hedges - a weak economy and heightened political tension have added to the unease."

The escalating threat of international trade wars and geopolitical disruptions have caused similar scepticism towards many global markets.  

"While it may be difficult or feel uncomfortable, capitalising on these low prices creates the potential for outsized returns once the panic passes," says Ahern.

"The true power of a properly diversified portfolio is that it helps you to achieve your goal even if you get some things wrong along the way."

investment  |  risk  |  money  |  diversification


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