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5 hacks to beat bad investing habits

Glenn Freeman  |  05 Sep 2016Text size  Decrease  Increase  |  

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These five behavioural hacks may help you prevent some of the most common mistakes of individual investors, according to Steve Wendel, Morningstar's resident behavioural finance expert.


In the investment world, many retail investors are simply yelled at, told to be smarter, not to be overconfident, and not to chase returns, says Steve Wendel, head of behavioural science in Morningstar's Chicago head office.

He doesn't mean "yelled at" in the literal sense, but refers to a constant barrage of presentations, advice, advertisements and other content purporting to tell people the best ways to invest.

"When we constantly tell people this, that sounds like we're telling investors that they're not smart, but that's not true. The challenge is that simply knowing about our human frailties--things like our tendency to chase returns--is not nearly enough to help us address them," Wendel says.

Instead, he urges investors to be smart by planning ahead for their moments of weakness, "to prepare yourself for the times you'll struggle in the market".

"The worst enemy of the investor is himself or herself, but it doesn't mean they can't fix this stuff," says Wendel.

There are a variety of techniques from behavioural science that people can use to change their own environment.

Wendel will discuss some of these in depth during the Morningstar Individual Investor Conference, which will be held in Sydney on 14 October 2016.

Self-help for investors

As a behavioural researcher, Wendel says he doesn't look at whether bad investment behaviour can be learned or unlearned.

"We chase returns because of how we're wired in our heads, and that's not going to change. But our environment can change. We can avoid our own bad behaviour by cleverly changing this," he says.

One of the most commonly-cited investor biases is overconfidence.

"This is where I think we're really advancing as a field: in hindsight they're often completely obvious. Of course people are overconfident. If we weren't confident, we wouldn't have a financial market to begin with," he says.

"But for too long the proposed solution has been 'just be stronger' and that ain't going to help anyone."

He says there are a number of less obvious ways we can change our environment, with five broad strategies investors can adopt, by changing:

1) The investment

2) Information

3) Interpretation

4) Decisions

5) Actions.

The first involves simply avoiding making investments that will be volatile.

"That's basically what risk tolerance surveys are about. Sacrificing some upside for downside protection, instead using things like hybrid vehicles," Wendel says.

This is the most familiar approach to most people, with a decision to invest in bonds instead of company stocks a common example.

"But much more interesting is changing the information," Wendel says.

By this, he refers to limiting the amount or scope of information you receive about your investment.

As an example, he refers to his own enjoyment of reading popular publication The Economist, a weekly business and current affairs magazine.

Instead of being a daily newspaper, its weekly publication cycle, "means that by definition, all the news is old news".

"That's wonderful, because it removes some of the reaction, the passion," he says.

This can remove the sense of urgency to react regularly to market changes or company announcements. Numerous studies show investors who trade less frequently perform better over the longer term than those who make frequent portfolio adjustments.

"So if you receive [the information] a week later ... then you can resist those rash actions, because you're choosing not to be exposed. Similarly, you can set up a regular meeting with your adviser, and say 'I don’t want to receive daily or weekly information, I want to only meet with you quarterly and don't to hear from you between these meetings," Wendel says.

"And of course, the other thing is to turn off the damn TV. Financial commentators' jobs are to get people excited ... and 'if you're excited, you're in trouble,'" he says, citing Daniel Crosby, a financial behaviourist from Atlanta, US.

His third point, interpretation, refers to looking at price movements as either negative or potentially positive occurrences.

"Contrarian investors have turned that around, they've changed how we interpret prices going down. Folks like Daniel Needham change this around to be about 'opportunity for profit'. The language we use matters," Wendel says.

In terms of changing the decision, this looks at addressing factors that are constraints on the individual. One approach Wendel suggests is to write a letter to yourself.

This could outline your overall approach and contain specific reminders, such as "I am a long-term value-driven investor ... though I will be tempted to stray, I'll be tempted when everyone's panicking about markets," Wendel says.

"In these moments of temptation, you can look back at that letter ... [to help overcome] this incredible ability that we have to self-deceive and to fudge things: get it written out plainly in front of you."

Social commitments can also help, such as engaging friends or fellow investors. "Tell them 'if you see me investing in a downturn, make fun of me, call me an idiot'. That's raising the stakes of making those bad decisions," Wendel says.

"By taking these actions in times of strength, you can make it harder for yourself to do these irrational things in the future."

More from Morningstar

Behavioural finance and how it hits your bottom line

Retirees draw on super slowly, don't blow the cash


Glenn Freeman is Morningstar's senior editor.

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