Investors understandably focus on things like company performance, market movements, and economic changes.
These things are, of course, important. However, what can sometimes fly under the radar is the significant role of investors’ own behaviour in determining their investment success.
Two investors with different behavioural profiles who invest in the same company or fund can sometimes achieve very different returns. This can happen if they respond differently to new information and, as a result, choose different times to invest, reinvest, or sell their investments.
For example, consider two investors who are broadly invested in the stock market at a time when the market experiences a significant decline. In response, both are likely to feel a degree of fear and anxiety. This is expected.
In addition, both might recognise the fact that despite the decline, in the long-term markets are likely to recover. In these circumstances, the ‘rational’ and ‘emotional’ drivers of their decision-making are in conflict.
For one investor, their psychological profile and investment habits might lead the rational arguments to have the stronger influence on their decision. They decide not to sell. For the other, the powerful emotional drivers might hold sway. They sell and avoid buying back in for many years.
We've seen it happen
In fact, this scenario accurately describes two very different ways people actually did respond to the Global Financial Crisis of 2007-2009. Those who held through this turbulent period, rather than selling in the midst of the gloom, have seen dramatic increases in the value of their portfolios as a result of a largely consistent bull market since the low point of the GFC in 2009, whereas those who have stayed in cash have missed all of these gains.
The conclusion from these types of examples is not that buying and holding is always the best strategy, simply that in many cases investors can profit from better understanding and managing their own behaviour.
Human behaviour is complex. But complex behaviour does not mean that it is entirely intractable, unpredictable, or unmanageable. Research into human decision making by neurologists, psychologists, and behavioural finance specialists has revealed three common themes:
- Human behaviour is often ‘context-dependent’. Our decisions can be heavily influenced by the circumstances in which we make our decisions, often in ways and to extents that surprise us.
- Human behaviour is often quite personal. While researchers can identify general trends that apply to investors on average, we should also expect substantial differences between different investors.
- Human behaviour is often influenced by things that operate beyond our conscious awareness. While most of our brain functions are subconscious, controlled laboratory studies, brain scans, and the analysis of real-world data can help to reveal these processes and to allow investors to better manage them.
