Humans often behave in emotional, and not always logical, ways.
This is particularly true when markets are highly volatile, which is common over the short-term.
Two forms of fear can drive investment decisions, even when those decisions may negatively impact investment performance over time: 1) fear of loss and 2) fear of missing out.
Fear of loss
When markets fall, our natural instinct is to sell.
That’s because humans tend to have a cognitive bias to avoid losses. We frequently make decisions to reduce our perceived risk of loss, even if it means missing out on potential significant gains over time.
So how does this fear hurt investment returns?
People fear additional losses after markets have declined, so they may sell when markets are low, only to buy back in later when the market has recovered. But trying to time the market – to sell at the right time and buy back in at the right time – is extremely difficult to do and even professional investment managers don’t get it right consistently.
Fear of missing out (FOMO)
It’s not just the fear of loss that can drive poor investment decisions.
FOMO is real and can cause people to overvalue ‘hot’ investments, frequently after they have already risen significantly and sometimes irrationally.
We saw this with the rapid popularity of buy-now-pay-later (BNPL) stocks in 2020 and early-2021. Their share prices rose to dizzying heights, but then most fell significantly when it became clear that the shares may have been overvalued.
Those who bought at or near their highs because they felt that everyone needed to own BNPL stocks proceeded to pay the proverbial price for acting on FOMO.
What might you do instead?
Instead of making investment decisions based on emotions, we recommend doing these two things if you have funds to invest:
- Setting up and maintaining a well diversified investment portfolio that aligns your asset allocation with your risk profile.
- Keeping calm and trying to avoid irrational emotional decisions by staying the course with your investment strategy. Remind yourself that short-term market volatility is a normal part of investing.
In our opinion, short-term (less than 1-2 years) investing in growth/shares/risky assets is more akin to speculating (or gambling) than investing. We believe “investing” is a medium- to long-term exercise. The majority of our clients invest for 10 years or more.
How Six Park helps you
Our investment management approach using diversified portfolios of Exchange Traded Funds (ETFs) helps investors to commit to their investment strategies and reduce the risk of being swayed by emotion or market sentiment.
Our globally diversified portfolios are tailored to your personal goals, risk tolerance and investment timeframes. The ETFs within your portfolio provide a low cost way to invest in an asset class or diversify within an assets class.
We take care of periodic rebalancing for you and regularly review the underlying investments in your portfolio to ensure we maximise the benefits of diversification.
Finally, instead investing all of your funds as a lump sum, you can consider investing smaller amounts more frequently by using the Invest on Demand or Automated Investing features in your Six Park dashboard or by setting up a regular transfer to your Macquarie CMA and take advantage of our included quarterly trading days on 1 November, 1 February, 1 May and 1 August.
Six Park provides you with one of the most rational and prudent approaches to reaching your long term investment goals.
This article may contain general financial product information but should not be relied upon or construed as a recommendation of any financial product. This information has been prepared without taking into account your objectives, financial situation or needs.
For further details on our service please see our Financial Services Guide at http://www.sixpark.com.au. Past performance is not a reliable indicator of future performance.