Behavioural finance: how to manage your instincts and protect your wealth
Investors need to make informed decisions, but this may be harder than you think. James Norton, senior investment planner at Vanguard, reveals his top tips.
When it comes to investing, we can be our own worst enemies. Whether we’re being over-confident or paying too much attention to the past or seeking out facts to confirm what we already think, biases can be dangerous for our wealth.
Here are my five tips for good investing behaviour, which may help to protect your money.
1. Be aware of your biases
Knowing that you have biases is a great starting point. After all, you can’t fix what you don’t know. While this sounds simple, it can be harder to put into practice.
For example, suffering from overconfidence isn’t easy to detect; the more overconfident you are, the less likely you are to notice it.
If you’re serious about finding out and getting feedback, ask a friend or colleague about your strengths and weaknesses. It may be enlightening!
2. Remember your goals
Remind yourself why you’re investing.
The next time you’re thinking of selling some investments or stopping your monthly savings plan as you want to spend your money on something else, remember why you started investing.
It’s about patience, not short-term gains.
If your aim is to achieve a comfortable retirement, for example, using your long-term goals to frame your decision-making will help to keep you on track.
3. Document your decisions
Managing behavioural biases is about overcoming emotional reactions to situations. So, it can be a good strategy to document your decisions.
Once you’ve decided how you want to invest and your reason for selecting certain funds, write it down. Consider writing down your goals as well.
When you next want to change the portfolio, check your notes and remind yourself of your original thinking.
It will help you learn from mistakes and hopefully prevent taking unnecessary action.
Good advisers have an investment philosophy – and so should you.
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4. Have a process
If you have a good process, it helps to remove some of the emotion from investing.
Decide how often you’re going to review your portfolio. It doesn’t have to be daily. Monthly, or even annually, will be enough for most investors.
Also decide how often you are going to rebalance your portfolio. Will it be annually or based on how much your holdings have moved?
It probably doesn’t matter which method you choose, but when you have one, stick with it.
That way, you don’t have to make judgement decisions on when to buy and sell holdings.
If this feels like too much work, some funds will do this for you. These funds keep the asset allocation constant via a disciplined rebalancing process so you can maintain the right level of risk.
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5. If in doubt, get an adviser
Many investors don’t have the time, willingness or ability to manage their own investments and that’s fine.
If that’s the case, find a well-qualified adviser who can act as your coach and make these decisions.
When selecting an adviser, it makes sense to check they have good processes and that their own biases are not too strong.
Finally, remember, investing does not have to be complicated or time consuming.
Buying a couple of low-cost, well-diversified funds and using your tax allowances where appropriate, will be the right solution for most of us.
Then you just need to sit back and let the investments take care of themselves, as well as check them on an occasional basis.
The next time you want to trade, just ask yourself “Do I really know better than the market?”. If the answer is no, which surely it would be for most of us, the best course of action is probably no action.
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