Investing is an incredibly personal thing. This is your hard earned money, the outcome of that investment could impact your future wealth. However, it is easier to recall recent events than it is to consider something over a long period of time.
If you fell down the stairs last week you are likely to be more careful over the next few weeks, but that ignores the hundreds of times you successfully descended the stairs. When it comes to investing this attitude can be detrimental to your long-term investment as you overestimate the importance of recent news stories.
Step one: Would you do something differently had the opposite happened?
Markets tend to undervalue stocks that have recently fallen in value whilst the reverse is true of stocks that have recently gained value.
When considering an investment, you should ask yourself ‘would I do something differently if events were reversed?’ If the answer is yes your short-term bias is controlling your decision. You need to ensure your decisions are considered and are backed up by more than just the recent news.
It is important to remember that an investment is part of your medium to long-term financial plan. In the 1980s the ‘founders’ of behavioural economics, Werner De Bondt and Richard Thaler found that stocks that were considered ‘losers’ outperformed those previously considered as ‘winners’ after 36 months. It is crucial that you find the balance between risk and reward that is right for you.
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Step two: If markets are moving quickly be aware
Money flows into the investment market at it’s fastest just before a financial crash and the slowest before a big upturn in prices. The opposite would be true if investors were optimising their decisions.
Decision making is vulnerable to emotions when markets are rising and falling quickly; this emotion may impair your logical thinking. When prices are rising an investor might feel optimistic or even excited, evidence is then collected that backs up that emotion leading to a purchase. If markets are going down, or an individual is losing money, fear and regret can lead to a sale or no investment at all.
Step three: Think about when you make your investment
If there has just been an upturn in the market you might wish you had invested earlier, if it has just fallen you might feel that further investment could be too risky. Realistically there is never a ‘good’ time to invest. But you should not make investment choices based on hope or regret.
The smart investor knows that an investment is for the medium to long term. Looking at past trends, an investment tends to be more likely to beat inflation than cash and that is what an investment is doing, protecting the real value of your hard earned money.
Saving in cash could limit your ability to grow wealth
Step four: Consider a discretionary investment
Using a discretionary investment service, such as Moneyfarm, takes a lot of the personal bias out of investing. Moneyfarm asks you the questions needed to understand your biases and create a risk profile appropriate to these. But the investment decisions are with a team of experts who constantly monitor the markets but also have a wealth of experience to consider past trends. The only decision you have to make is when to enter the investment space.
