Behavioural Finance Why you invest the way you do
Human behaviour and our responses to external and internal motivations are fascinating, and whilst most of us would like to think that we are careful, consistent and well informed in the way that we take decisions, especially when it comes to major issues like our savings and investments, the truth is that we all think and respond in different ways. The manner that we process information in order to reach decisions comes from deep within our psyche; consciously or unconsciously we all have biases which affect the way we think. How does this work?
There is also the matter of group, or herd mentality. Investors often see an opportunity or trend and behave as a crowd, following each other to buy or sell in particular sectors or within certain funds, where they perceive performance is strong. The dotcom bubble of 1999-2000 is a good example of this. It’s an approach which works if you can jump in when share value is low, but if you wait until everyone is on board then you will be buying at the top of the market. As John D Rockerfeller is supposed to have said before the Wall Street Crash: when the bellhop in your hotel starts talking about share tips, it’s time to get out of the market. Herd mentality also comes into play where something unexpected happens such as a major fraud is uncovered, or a bank collapses, or a retail group looks as though it is about to go into administration and everyone races to offload their investments, which can lead to lost returns for individual investors. Further behavioural tendencies which may influence investment decisions include confirmation bias, or the tendency to believe what we think confirms an existing opinion, and disregard anything which contradicts it. This may mean for example that an investor believes that the best prospect for growth is from medical technology, and they decide to invest heavily in that field, even though there may be evidence that other sectors are performing better. Ultimately you will not be making a balanced decision, instead choosing to believe what they want to believe.
Developing a level of emotional intelligence in order to understand these behavioural aspects of people’s attitudes to investing is a fundamental attribute for an Independent Financial Adviser. “Listening, coaching, mentoring and advising are not opportunities for a hard sell,” says Grant Buchanan, Financial Advisory Partner at Scrutton Bland. “Understanding our clients, being patient and supportive throughout their relationship with us are going to get a better result than pushing them into an investment they aren’t happy with. We need to understand the way a client thinks: their attitude to risk and reward, and what their long- and short-term objectives are. Some people have said that financial advice is an art and not a science; I wouldn’t go that far but I would suggest that if you are open to the idea of a personal trainer to improve your fitness levels, you should be able to work with a financial ‘trainer’ who can work with you to get the best results for your individual circumstances.” When thinking about investing we suggest that clients complete a risk profile to ensure that they understand the details of their investment and levels to risk, whether this be by using an online facility like sbinvest or when meeting an Independent Financial Adviser. For more information on the ways that an Independent Financial Adviser can work with you contact hello@scruttonbland.co.uk or call 0330 058 6559 .
Studies have shown* that, for example, most people believe their driving skills are above average, even though logically this cannot be the case. Similarly, some people display an overconfidence in their own ability to select successful investment options**. This can mean that they are overoptimistic about their view of the prospects of their ‘safe’ shares, and underestimate or even ignore the effect the performance of the overall market may have on their investments. This in turn increases the likelihood of a negative performance on their investment.
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