Investors losing 3% a year to emotional decisions

Research finds over-reacting to economic issues can actually make you poorer.

Decisions investors make for emotional comfort could be costing them 3% or more a year, according to research.

The figure could be even higher, because of increased market volatility during the pandemic leading to a rise in this sort of decision.

Behavioural finance experts at Oxford Risk found investors who increased their allocation to cash due to coronavirus economic fears could be losing out on 4% to 5% a year in returns over the long term. 

Separate research from Janus Henderson Investment Trusts in September found savers are holding record amounts of money in cash as a result of pandemic-induced fears. 

The fund manager calculated this has cost UK households £38 billion in missed income over the last year.

In addition, Oxford Risk estimates the ‘behaviour gap’ – investing more money when times are good for stock markets and less when they are not, resulting in buying high and selling low – on average costs investors around 1.5% to 2% a year over time.    

Research by the company found there are behaviours that are common to many investors in volatile times.

During a crisis, investors are likely to focus too much on the present and on the detail, feeling compelled to do something even when doing nothing is the best solution. 

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They can gravitate towards the familiar – often leading to underinvestment, selling low or decreased diversification. 

Marcus Quierin, chief executive at Oxford Risk, said many of these actions will mean investors turn paper losses into real ones. 

He said:

“The investments in the news are not your investments. Retail investors should avoid watching the markets day-to-day as this will only increase anxiety to no useful end, and make you feel like you should be doing something, without any useful guidance to what that should be.”

Long-term plans, he added, should be looked at through long-term lenses. “If they don’t need to withdraw money for immediate expenses, then the losses are only virtual, until they panic and make them real,” he said.

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Investors should instead focus on what they can control, like postponing discretionary spending, rather than chopping and changing investments in the face of fast changing markets. 

The benefit is the ‘risk premium’ – the long-term reward for owning shares that has eventually weathered every short-term economic storm yet.

Greg Davies, head of behavioural finance at Oxford Risk, which makes software it claims can counteract biases that can creep into these adviser processes, said: “Understanding a client’s financial personality is typically limited to risk profiling and subjective human assessment. 

“Advisers need to be assisted by better diagnostic tools enabling accurate assessment of the client’s personality and likely behavioural tendencies.” 

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