What are the consequences of this emotional roller-coaster?
Emotions turn rational investors into irrational investors.
So, it is important to remember that markets move and investments will always go in and out of favour.
Developed, diversified long-term financial plans are placed in jeopardy when investors are confronted by extraordinary events because we are guided by our emotions.
You can avoid the emotional roller coaster by being aware of the emotions you are likely to experience.
The five most common behavioural pitfalls are:
- Overconfidence – when investors over-rate their ability to select winning shares or investment managers.
- Loss aversion – research indicates a loss causes about twice as much pain as a gain causes pleasure. During periods of market volatility investors experience the sense of loss more acutely.
- Chasing past performance – we see this time and time again, but unfortunately, individual investors who are abandoning a well-diversified portfolio for bonds, or even cash, may be jeopardising their future financial security.
- Timing the market – research shows that no-one can accurately time the market.
- Failure to rebalance – the risk/return characteristics of an investor’s portfolio should be independent of what’s happening in the market and this means selling high and buying low.