How and understanding of Behavioural Finance can help you make better investment decisions
Have you ever purchased an investment after reading an article, watching the news or hearing from a friend how it’s a sure win? The fact is that our investment choices are often swayed by a range of internal and external factors – whether they make financial sense or not.
According to Peter Nieuwoudt, an Advisory Partner of Consolidated Wealth, there is a field of economic study dedicated to understanding the factors that influence investor decision-making, that explain why otherwise rational people make poor investment decisions.
“Behavioural Finance is one of the most exciting and often controversial areas of economic study. In a nutshell, it is the study of the psychological influences on investor behaviour. It focuses on the fact that investors are not always rational, have limits to their self-control and are influenced by their own biases. In short, they are human,” Peter explains.
Because we are not machines working on predictable algorithms, the reality is that our decisions – including our financial decisions – are wrapped up in emotions. How we feel can often cloud our judgement.
“Behavioural Finance helps us to be aware of our biases and to understand how they can influence investment behaviour so that we can avoid the pitfalls they tend to lead to,” says Peter.
Peter’s top strategies to guard against negative behavioural tendencies in relation to investing are:
1. Create a sound framework
According to Warren Buffet, the recipe for successful investing starts with creating a sound framework. Either working by yourself or with a financial advisor, this means putting together a plan that will grow and preserve your wealth in the long-term.
A financial expert will help you tailor this to your unique circumstances so that you build a portfolio that reflects your relationship with your money and that is aligned to your priorities. Once you have your framework in place, a financial advisor will also help you to stick to it.
Investing in the stock market is not a path to get rich quickly. Buffet – one of the most successful investors ever – believed that it is best to moderately grow wealth over long periods of time, so your goal is to secure quality investments that will compound in value over many years. The adage of “buy right and sit tight” is the best way to build wealth.
2. Don’t let emotions corrode your framework
Most of the news headlines and conversations in the media and social media are there to generate buzz and trigger our emotions. And when investors let emotions guide their investment decisions, it translates to buying when prices are high and panic selling when prices fall.
This was again evident this year as the market responded to the Covid-19 crisis. The Coronavirus and the subsequent nationwide Lockdown resulted in the JSE losing a third of its value in March causing many investors to panic unnecessarily. History has shown us time and again that it pays to think beyond the present – markets are cyclical and waiting out short-term volatility is essential to your portfolio’s success.
3. Only listen to those you know and trust
We may not be able to control how our investments perform in volatile markets, but we can certainly control who we listen to when it comes to selecting investments and managing our portfolios. The financial world is filled with many characters and unfortunately, there are those who prey on investors’ unrealistic expectations and feelings of fear and greed to make a quick buck.
That’s why it is critical to ensure that you are working with a reputable financial planning company with experienced financial advisers. Experts in their field, they have an understanding of investor psychology and will play a critical role in your relationship with your money.
Most importantly, a competent adviser will assist you in making objective and rational decisions against the backdrop of your own fears, prejudices and concerns, using their knowledge and understanding of Behavioural Finance to anchor you and your portfolio in times of market turbulence and political uncertainty.