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Avoiding Emotion-driven Investment Decisions

Throughout the course of financial history, investors have shown tendencies to abandon their investment strategy due to various emotional and/or psychological factors. These behaviours have frequently led to poor investment returns over the longer term.  

Numerous studies in behavioural finance have demonstrated that people tend to have a cognitive bias to avoiding losses – or in simple terms, they tend to dislike losing money far more than they enjoy making it. This phenomenon (often referred to as “loss aversion”(7)) means investors will often make sub-optimal decisions in an effort to reduce their risk of loss, even if it means missing out on significant gains.  For example, during times of market downturns, it is not uncommon for investors to panic, particularly as the emotional challenge of seeing their portfolios fall mounts over time. During these times, many investors will end up selling out at or near the bottom of the market (regardless of the quality of their investments and their long term prospects) - only to then buy back in at a later stage once the market has recovered and they have sacrificed huge potential gains. A similar loss aversion bias can occur when investors choose to delay (or avoid) the sale of poorly performing investments because they do not want to formally crystallise any real losses (and prefer to wait to see if their unrealised losses reverse in the future).  

It is not just the fear of loss which can drive poor investment decisions. The “fear of missing out” can also cause people to make over-allocations to “hot” investments. Driven by our innate “herd mentality”, individuals have a tendency to mimic the actions of a larger group – even if such choices are potentially irrational and would not necessarily be the choice most people would make individually.  In the financial world, this often arises during times of asset bubbles - periods when particular sectors grow rapidly and attract significant investment.  During these periods (such as the technology stock boom of the 1990s), investors are lured into making over-allocations to opportunities, reassured by the fact that others are doing the same thing and are making strong returns. These emotion-driven decisions can lead to disastrous results when the inevitable market corrections eventually arise.

Six Park provides a disciplined platform for investors to stay the course with their investment strategies and not be swayed by emotions and/or market sentiment. Guided by the deep expertise and experience of our Investment Advisory Committee, we offer investors globally diversified portfolios which are tailored to their personal goals, risk tolerances and investment horizons. While this approach naturally cannot guarantee that you will outperform other “lucky scores” you might otherwise make from time to time, it will help you avoid the pitfalls of emotional driven decisions whilst providing the most rational and prudent approach to reaching your longer term desired investment goals.

(7) First demonstrated in Kahneman, D. and Tversky, A. "Choices, Values, and Frames" 1984

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