Eight Reasons to be Wary of Yourself in 2020

2019 was certainly a rock 'n' roll year for many reasons but despite the volatility a number of the worlds stock markets finished on double digits.  Will 2020 produce similar results? This got me thinking that this period of our history seems to be particularly challenging in many ways and reminded me of the time I went to the USA for a road trip up the West Coast. During this trip I took a detour to an old mining town known as Bodie ghost town (see photo above). Apart from the fact that this is a national monument in the US and a great window into the past, one thing really struck me here. Walking around I came across the old church and peered through the window. Above the pulpit was a large wooden banner with the following inscription craved into it:  "Nothing endures but change":  Heraclitus It seems kind of fitting that a ghost (abandoned) town would have a reminder of the fact that our lives are perpetually moving and we are constantly at the mercy of change, be it climatic change, political change, job change or even changes in the family.  However, this change represents not only dangers, but also great opportunities. This then led me to think about my work as a financial planner and how it is critical to helping you plan around this insecurity, hopefully bringing peace of mind and putting plans in place to ensure that big change affects us less than if we hadn't made those plans. The dichotomy here is that to bring about this security, we have to accept insecurity. What I mean by this is that to create the plans to secure your future, you need to take some risk in the investment markets to keep your money at pace with inflation, whether you are in retirement and needing to take income from your savings or you are someone of working age who needs to accumulate for the future. The bottom line is that the only mechanism available to us to protect the future and provide the stability we need is to enter our money into a world of flux and change. But this needn't be as angst provoking as it might sound, because we are all human and the best thing about being human is that we are all very predictable. We instinctively behave in certain ways and these have been researched and proven time and again. The name of this area of study is behavioural science. So, in this blog I thought I would write about the traits that exist in all human nature and that skew our thinking in the way we deal with our own money.

Fortunately, most human behavior is learned observationally through modeling from others Albert Bandura Professor Emeritus of Social Science in Psychology at Stanford University

Behavioural finance is a study of our human tendencies that lead us to make illogical and often irrational decisions, especially when it comes to investments and our money. A prime example of this is that our emotional response to 'perceived' losses (not actual losses) is different than to that of perceived gains.  Studies show that losses for an investor feel twice as painful as gains feel good. Others worry more about the return on their wealth than they do about the amount of their wealth. This thought process can cause us to fixate on the wrong issues and that's where good financial planning comes in. The Psychology of Investing Biases Behavioural  biases affect ALL of us and can vary depending on your personality type. These biases can be cognitive: a tendency to think and act in a certain way or follow a rule of thumb, or emotional: a tendency to take action based on feeling rather than fact. A study was conducted by H. Kent Baker and Victor Ricciardi that looked at how biases impact investor behaviour. Here are the main eight biases that are thought to affect investment decisions and some examples of them in action: See how many you can identify in your own behaviour regarding your money? (I recognise a few in myself. The important thing is to recognise your behaviour and act on it appropriately and not emotionally). 1.  ANCHORING OR CONFIRMATION BIAS: We tend to selectively filter, paying more attention to information that supports our opinions while ignoring the rest. Likewise, we often resort to preconceived opinions when encountering something — or someone — new. You might be suffering from confirmation bias on Facebook! Facebook is a great example of this.  We normally have a FB feed of posts that support our opinions and beliefs and rarely subscribe to posts that we don't agree with.  When it comes to money we are more likely to look for information that supports our ideas about an investment, rather than seek out information that contradicts it. 2.  REGRET AVERSION BIAS: Also known as loss aversion, regret aversion describes wanting to avoid the feeling of regret experienced after making a choice with a negative outcome. Everyone knows that a risk free investment with a 10% return each year is a unicorn.  It just doesn't exist.  But if you think that something will not perform well, based on your opinion and not researched facts, then you will take less risk because it lessens your potential for poor outcomes. This explains why people are reluctant to sell losing investments, because it avoids confronting the fact that you have made poor decisions. 3.  DISPOSITION EFFECT BIAS: This refers to a tendency to label investments as winners or losers. Disposition effect bias can lead an investor to hang onto an investment that no longer has any upside or sell a winning investment too early to make up for previous losses. This is harmful because it can potentially increase capital gains taxes and can reduce returns even before taxes.  At The Spectrum IFA Group we use well established asset managers whose job it is to do this so you, our client, don't have to worry about it.   4.  HINDSIGHT BIAS: Another common perception bias is hindsight bias, which leads an investor to believe after the fact that the onset of a past event was predictable and completely obvious whereas, in fact, the event could not have been reasonably predicted.    Think about the financial market collapse of 2007/2008 and how many pundits, after the event, were saying that we should have known.  In fact Queen Elizabeth II was famously caught asking her hosts at the London School of Economics "Why did no one see it coming?"   5.  FAMILIARITY BIAS: This occurs when investors have a preference for familiar or well-known investments despite the seemingly obvious gains from diversification. (The undoubted winner in this category is...PROPERTY...its quality of being tangible leads it to being most investors' favourite choice). You might feel anxiety when diversifying investments between well known domestic stocks and lesser known international ones, or anything outside of your comfort zone. This can inevitably lead to sub-optimal portfolios with much greater risk of losses. Culturally, most Italians have been big property investors, in some cases sinking their life savings into buying a property for themselves and then, where possible, one for the kids.  However, the continued economic crisis in Italy has exposed the increased risk of this investment strategy.  Most properties, outside the big cities (location location location), have seen dramatic falls in prices over the last 10 years and selling the property itself can take a long time.  In addition, when the government wanted to raise tax revenues in 2014 they headed straight for property as their golden egg.  Conversely, if they had diversified their assets into bonds and shares over the same period they would have seen their family wealth appreciate considerably.  6.  SELF ATTRIBUTION BIAS: Investors who suffer from self-attribution bias tend to attribute successful outcomes to their own actions and bad outcomes to external factors. They often exhibit this bias as a means of self-protection or self-enhancement. For all the ladies out there, you might be happy to know that men are much more inclined to be affected by the self attribution bias than women. A good barometer of over confidence in investing is how much someone will buy and sell in their portfolio in any one year. (It's a bad thing to turnover the portfolio too much because in increases costs and reduces returns).  Studies found that single men tended to trade 85% of their portfolio in any one year, whereas a single woman was likely to turnover just 51% of her portfolio. Married men fared slightly better than single men at 71% and married women at 53% (clearly under the influence of over confident men!)  7.  TREND CHASING BIAS: Investors often chase past performance in the mistaken belief that historical returns predict future investment performance. This tendency is complicated by the fact that some product issuers may increase advertising when past performance is high to attract new investors. Research demonstrates, however, that investors do not benefit because performance usually fails to persist in the future. It's interesting to note that almost every graph of investment performance for any investment (at least the ones I have seen) will always follow a rising line from left to right. Much like any other industry, it's all in the marketing. The key is not to get taken in by the hype! 8.  WORRY: The act of worrying is a natural — and common — human emotion. Worry evokes memories and creates visions of possible future scenarios that alter an investor’s judgment about personal finances. (Iran/US war for example).  Anxiety about an investment increases its perceived risk and lowers the level of risk tolerance. To avoid this bias, investors should match their level of risk tolerance with an appropriate asset allocation strategy. My experience of working with many different people over the years is that the predominant characteristic for everyone is worry. It might be, like in my case, the worry about how much money I will need when I am older on which to retire, or from the view point of someone who is already retired, how long their money will last them before it runs out. This is where technology comes in. I now use online forecasting software to alleviate those worries.  This is a tool, where, with the input of your financial data we can create a plan for the future and answer questions, such as 'how much will I need to live on when I am retired' and 'how long will my money last'? If you are worried about your situation and the years ahead, then just ask me and I can complete a forecast for you. I have been surprised at how useful it is in helping clients to better understand their finances, reduce worries for the future and focus on the amount of wealth you have rather than the annual return.      How to avoid these Behavioural Mistakes I can help you to understand your common behavioural mistakes and then we take the emotion out of investing by creating a customised tactical, strategic investment plan. This might include:  Risk Profiling: Completing a risk profile questionnaire to identify and understand your appetite for investment risk.  This is also about exploring your expectations for returns and your capability to accept losses.  Using professional asset managers to look after your money within the parameters of your risk profile. This removes any emotion and puts the money in the hands of professional money managers who use factual data to measure risk and deliver returns.  The most important aspect of behavioural finance, by a long way, is your peace of mind. By having a thorough understanding of your risk appetite, understanding why your portfolio has been chosen and what is in it, it allows you to feel much more at peace with your investments and be less likely to make common behavioural mistakes. My forecasting software can help you to avoid making investment decisions based entirely on those biases and provide you with peace of mind for the future. If you are interested in running through the exercise then just drop me a line on gareth.horsfall@spectrum-ifa.com.  You can also call me or message me on whatsapp: 3336492356.