Savings & Investments

5 investor biases to avoid when the market is volatile

This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice please consult us here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.

At the time of writing (May 2020), few people are certain of where the markets are heading and you should probably be wary of anyone confidently predicting what will happen. Indeed, our financial advisers here at Elmfield have held numerous consultations with people in Padiham, Burnley and across Lancashire about how to best prepare their investments for different scenarios. The situation is very volatile at the moment.

For instance, in March the markets looked very dire. The FTSE 100 reeled in the wake of the COVID-19 pandemic and subsequent lockdown, suffering its worst quarter since the terrible economic decline of 1987. By the end of April, both the UK and other global markets seemed to be recovering slightly, with the FTSE 100 hitting a 7-week high as hopes of lockdown easing spread across the business sector. In May, however, markets are still on shaky ground despite the beginning of a lift in social distancing and self-isolation restrictions, with UK indexes only just edging into positive territory.

All of these fluctuations can make it very difficult for individual investors to know what to do, and is the perfect climate for impulse decisions to be made which are, often, regretted later. In this short article, our Lancashire-based financial advisers here at Elmfield identify 5 investor biases (or “mistakes”) to be aware of during these turbulent times.

We hope this content aids your thinking. If you’d like to speak to an independent financial adviser you can reach us via:

T: 01282 772938

#1 Availability bias

Have you heard a lot about company Y’s shares in the news lately? Perhaps they were doing especially well in the wake of the COVID-19 pandemic (e.g. manufacturers of face masks and/or hand sanitiser). This can lead an investor to put more money into this company than they might have otherwise done, possibly even jeopardising the balance of their portfolio.

Alternatively, perhaps you heard of a particular company or sector doing badly, leading you to behave in the opposite direction – pulling money out. Be very careful with this kind of availability bias, which can lead you astray.

#2 Recency bias

Here at Elmfield, our financial advisers sometimes encounter people in Lancashire who think that the markets will imminently get worse, because the economy has been in bad shape recently. Others look at the encouraging signs from the FTSE 100 and other indexes in April and May, and believe that the markets will soon re-enter “bull territory”.

It is common for investors to draw a conclusion from the most recent evidence and assume that this trend will continue in the coming weeks and months, possibly leading them to adjust their portfolios accordingly. Again, be careful not to fall foul of this recent bias.

#3 Loss aversion

Suppose you own a range of stocks in companies which have lost value (a common experience of investors in the first quarter of this year). You check the “fundamentals” of these companies and decide they are still very much valid. Yet, the temptation remains to pull your money out.

Why? Because many people wish to avoid further loss or financial “pain” in such circumstances. This is a natural reaction, but it can have disastrous consequences later. Especially if the companies in question recover in future months/years, and even surpass their previous values.

#4 Anchoring

The “endowment effect” refers to the natural human tendency to place a higher value on those things which we already own. This can make it hard for some people to let go of an investment when the time has really come to move on.

Others are willing to release an “expired” investment, yet only when it has at least returned to the value at which it was originally purchased. This anchoring can be detrimental to a portfolio, particularly if the fundamentals of your company investment have deteriorated.

#5 Bandwagon effect (or groupthink)

This is one of the most prominent and apparent investor biases, yet it’s still so easy for even the most seasoned investors to fall foul of it. If you see other people around you (e.g. friends and relatives) pulling money out of the stock market, perhaps due to volatility caused by COVID-19 and the lockdowns, then it can be hard not to follow suit. After all, we tend to assume that the majority cannot be wrong.

Unfortunately, that’s not the case. It is possible for people to make costly mistakes, especially when money is involved and stakes are high (e.g. your life savings have fallen in value by 20%). To be a successful investor, therefore, it’s vital to be able to analyse and think independently. Be careful not to simply follow the crowd, particularly when markets are unstable and people are running for the door. You could miss out on some incredible investment growth down the line, had you simply been patient and “stayed in the market.”

Conclusion & invitation

If you are interested in starting a conversation about your financial plan, then we’d love to hear from you. Get in touch to arrange a free, no-commitment consultation with a member of our team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.

Reach us via:

T: 01282 772938