Fear and greed. In Fisher Investments UK’s experience, these emotions can materially influence investors’ market views – and their investment decision-making. We have found allowing emotions to dictate portfolio decisions raises the risk of making mistakes. In our view, being aware of potential pitfalls can help investors remain disciplined in their approach.
In our experience, fear often stems from prior market losses, and in many cases, we find acting on this emotion can lead to missed opportunities. Behavioral finance studies have found people dislike losses so much, they are willing to go great lengths for the perceived chance of avoiding more – even if doing so comes with potentially harmful longer-term costs.[i] For investors, this can take the form of selling positions when they are down in hopes of avoiding further losses. But in Fisher Investments UK’s view, this behavior is much riskier than many think. Not only does selling whilst down lock in losses, but it may also mean missing the opportunity to benefit from the position’s recovery. Our research shows past returns don’t dictate the future, so if the position rebounded and the investor in this scenario wanted to buy back in, they may be doing so at a higher price than they sold it for – furthering the damage.
Yes, negative stretches can be emotionally trying. But for investors whose long-term goals, needs and risk tolerance aligns with equity-like returns over time, Fisher Investments UK’s reviews of market history suggest participating in downturns doesn’t prevent reaching long-term investment objectives. For example, global equities’ long-term annualized return of 10% includes bear markets and other downturns.[ii] Thus, we think investors who stay disciplined during these periods will be in a position to reap the benefits in the longer run.
Conversely, we have found greed can cause investors to assume more downside risk in search of greater gains. Fisher Investments UK’s knows that acting on greed can take many forms, including investing with emergency funds, concentrating your investment in too few equities or sectors or buying an investment due to recent hot returns. But one example we find extra risky is investing with leverage (borrowing funds to invest). Using leverage carries higher upside potential, as borrowed funds provide investors with more capital to deploy. But there is big downside, too: investing with leverage risks losing more than your initial investment. In some cases, leveraged traders may receive a margin call from the lender, which forces the investor to deposit even more of their own funds if their margin account falls below a certain amount. Or, in the absence of additional funds to meet the call, brokerages can force investors to sell after a decline – introducing all the associated problems we mentioned previously.
Fisher Investments UK’s reviews of market history show volatility can occur for any or no reason at all, so if negative volatility arises, heavily leveraged investors may find themselves in a tough spot. Whilst using leverage may seem irrational on its head, we have found greed can blind investors to downside risks. In our view, seeking market-like returns can help investors set realistic expectations – a useful counter to greedy behavior. Understanding what is and isn’t probable can help dissuade investors from chasing hot categories or investments.
Before making any portfolio decision, we think investors benefit from asking themselves a few questions. First: what is the thesis for this action, and is it forward-looking? Fisher Investments UK’s reviews of market history suggest equities care most about the economic and political factors most likely to affect corporate profits 3-30 months in the future. So we think it makes sense to question and discard any thesis inspired by past events and market movements. Second: how does this move align with a long-term investment plan? In Fisher Investments UK’s view, investors benefit from constructing and maintaining a financial plan best suited for their specific objectives, needs and risk tolerance. If an investing decision deviates from your plan, it may be useful to consider its fit in your strategy. Finally: what if the move is wrong? We find that a sign of an emotion-based decision is failing to consider the true costs of error – and even often includes even the failure to weigh that any decision could be wrong.
Whilst it may be easy to make snap investing decisions, we think it can be beneficial to take some time first and consider the driving force behind the change. Not only could doing so help you stay on track to meet your long-term investing goals and objectives, but it may also help avoid making emotion-based decisions.
Disclaimer:
This document constitutes the general views of Fisher Investments UK and should not be regarded as personalised investment or tax advice or a reflection of client performance. No assurances are made that Fisher Investments UK will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. Nothing herein is intended to be a recommendation or forecast of market conditions. Rather, it is intended to illustrate a point. Current and future markets may differ significantly from those illustrated here. In addition, no assurances are made regarding the accuracy of any assumptions made in any illustrations herein. Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited has its registered office at: Level 18, One Canada Square (NYSE:SQ), Canary Wharf, London, E14 5AX, United Kingdom. Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission.
Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission. Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.
[i] “The Effect of Myopia and Loss Aversion on Risk Taking: An Experimental Test,” Richard H. Thaler, Amos Tversky, Daniel Kahneman and Alan Schwartz, The Quarterly Journal of Economics, May 1997. “Prospect Theory: An Analysis of Decision Under Risk,” Daniel Kahneman and Amos Tversky, Econometrica, March 1979.
[ii] Source: FactSet, as of 14/2/2023. Statement based on MSCI World Index annualized return with net dividends in pounds, 31/12/1970 – 31/12/2022. Citing in British pounds due to the euro’s limited history. Currency fluctuations between the euro and pound may result in higher or lower investment returns. A bear market is a prolonged, fundamentally driven broad equity market decline of -20% or worse.