Wealth Insights  (October 2018)
Taking the emotions out of investing

Vasu Menon, Vice President & Senior Investment Strategist, OCBC Bank

Making an investment decision goes beyond objective analysis. Our investment choices are often affected by our emotions or biases which can result in poor outcomes. It is not easy to take the emotions out of investing but being aware of behavioural biases can help us to make less emotional decisions and better investment choices.

Home bias

There is tendency for investors to invest in assets in their own country because of familiarity.

Investors often confuse familiarity with knowledge, and therefore suffer from over-confidence with local markets or investments that they are more familiar with.

However, things can go wrong with the economy and financial markets at home and it makes sense to reduce this risk by diversifying geographically.

This is especially so if you are employed in your home country and have bought a house there and invested in other properties as well, in which case you already have significant exposure back home and may be inadvertently taking on more risk than you realise when you tilt your portfolio towards stocks and bonds listed at home.

There could also be attractive global investment opportunities you are missing out on by being too home-centric. For those with the means and know-how, they can do their own research and buy into individual stocks listed in other markets.

For those with less time on their hands, a good way to invest in overseas markets is through unit trusts or funds available here.

The trick of course is to pick the right fund managers and right funds, and this is where a good relationship manager supported by good research can help you to zero in on attractive fund ideas.

Confirmation bias or Anchoring

People are often drawn to information or ideas that validate their existing beliefs and opinions.
For example, an investor may have a view about a stock and may gravitate towards information sources that confirm that view to justify why he should purchase the stock or hold on to it even though the share price may be doing poorly.

One way to overcome this is to read widely and to consider information from multiple sources. It is important to be objective when evaluating an investment and to keep an open mind about alternative views that may contradict what your belief. Bouncing your investment ideas off a financial advisor may be helpful in getting an alternative view.

Overconfidence bias is the tendency among investors to overestimate their predictive abilities.
Such overconfidence can cause unnecessary losses if it lulls an investor into complacency and results in excessive risk taking. If markets do not turn out the way an investor had predicted, he may refuse to accept his mistake and may cling on to his investment, resulting in larger losses than if he had come to terms with his mistake and cut losses.

Investors need to stay objective and not take on excessive and concentrated risk because they are sure minded about their prognosis. Careful and thorough research and diversification are ways to reduce risks that come with overconfidence bias.

One way to overcome the overconfidence bias is for Investors to seek help from an investment advisor who can offer independent and objective views and help manage their emotions and expectations during market downturns.

Recency bias

Recency bias is the tendency for investors to chase investment performance by looking at the recent strong
performance of an investment and assuming that this can continue unabated in future.

Past performance is no guarantee of future performance. In fact, when an investment has done very well in recent years it pays be to extra careful because the easy money may already have been made and you could be buying at the peak.

To avoid making poor investment decisions based on past performance one should delve into the reasons for the strong performance to see if it was due to exceptional factors which may not recur. Also, get a sense of the investment’s valuation to assess if it’s still fairly-valued.

Herd mentality

Some investors take comfort from the fact that many others are piling into an investment and follow the herd without doing careful research first or assessing if the investment suits them.

It is important to stop and ask yourself why you are making an investment and looking to see if it aligns with your risk appetite and financial plan.

Cryptocurrencies are on example of how herd mentality can result in substantial losses.

One way to overcome the herd mentality bias is to be extra careful when you hear too much of hype about an
investment which has already rallied sharply. In other words, be fearful when others are greedy. Don’t let greed get the better of you.

Loss aversion bias

Loss aversion or regret aversion describes wanting to avoid the feeling of regret experienced after making a bad investment decision by avoiding riskier investments.

Avoiding risk may limit your ability to grow your wealth and could affect the achievement of longer term financial goals like building an adequate nest-egg for a comfortable retirement.

Regret aversion can also explain an investor’s reluctance to sell losing investments to avoid confronting the fact that they have made poor decisions.

Investors need to face the reality that they are only human and may be susceptible to poor investment decisions from time to time. The key thing is to learn from mistakes to minimise losses in the future. To minimise losses, do careful research before investing, do not over-invest in anything and stay diversified to reduce risk. Also, do not focus only on returns when making an investment, be mindful of the risks as well and only buy products that suit your risk appetite.

Getting a financial advisor who doesn’t have your emotional baggage to review your portfolio and suggest how you can make changes to the portfolio may be one way to overcome regret aversion.

OCBC MoneyMonday™