Dumb things we do
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Human beings are hardwired to make poor decisions when it comes to investing. Our natural tendency is to buy at the top of the market cycle and sell at the bottom. Unfortunately, that quickly destroys wealth.
The good news is that financial planning advice can help. Advisers provide structure and discipline that can overcome our natural inclinations and emotions.
About 10 years ago, author Carl Richards released his finance book ‘The Behaviour Gap’. It explored why most of us make irrational decisions when it comes to our money. It’s not that we’re dumb. It’s that we’re hardwired to avoid pain and pursue pleasure.
And it’s why our emotions are unhelpful when it comes to dealing with the ups and downs of investment markets. After periods of strong positive returns, we feel excited and don’t want to miss out, so we invest our money.
Rising markets inevitably fall. After periods of negative returns, we feel fear and crave security. So, we sell.
And that’s the last thing we should do. Repeat that pattern enough times and you’ll go broke.
A better way
We should reverse the pattern. Theoretically, it’s much better to sell when markets are up and buy when markets have fallen. Better to be greedy when others are fearful, and fearful when others are greedy.
Of course, that’s really hard to achieve. It’s impossible to time the peaks and troughs of investment market. Usually rising markets continue on for longer than we expect, only to suddenly freefall. And contracting markets always fall further, faster and for longer than any of us can anticipate.
Buy and hold
A more practical approach to investing is to buy and hold investments over the long-run. American research house, DALBAR has proven the prudence of a long-term buy and hold approach to investing.
For more than 25 years, DALBAR has measured the benefits of the buy and hold investment strategy with its Quantitative Analysis of Investor Behaviour. According to the study, the average US share investor experienced a return of 5% lower than the US market return in 2019. Poor investor behaviour cost the average investor 5% in just a year.
Over longer periods, the cost of switching investments is even more pronounced. During the period 2016 to 2019 the average share investor in the US earned 25% less than the US market return.
What this means for retirees
Unfortunately, most retirees can’t afford to buy and hold their investments over the long run. Most retirees need to sell down investments over time in order to live.
But we can sell our investments within a disciplined framework. We can compartmentalize our money and separate our long-term investments from our short-term buffer and cash reserves.
Then when we’re looking to replenish our cash buffer, we can control whether we’re selling quality assets at depressed prices. It’s much better to sell assets after they have risen in price, even if the market continues to climb.
Nobody ever went broke taking profits. And at When Financial Solutions, we apply a framework to help overcome the emotions of investing.
So, if you partner with us, it’s not a matter of ‘if’ you will overcome the emotions of investing, but ‘when’.
Michael Bowman and James McMaster are co-founders of When Financial Solutions. This article is general and does not consider your personal circumstances so it may not be appropriate to you. If you would like advice specific to you, please give us a call.