Investments Can You Beat Your Investment Brain?

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In the past, an investor had to wait for a written statement or visit to his bank manager to see how his investments had faired. In the internet age, you can log on to a portal and get live updates by the minute. You also have 24 hour news and a wealth of information available on almost any subject on offer at the touch of a button. Mobile technology means that going home or on holiday is no escape from the interactive world.

Does this make everyone a better investor? Long established concepts of behavioural theory say that it does not.

Imagine making a simple bet. If you win, you make £1,000. If you lose, you pay £700. Would you take it? Perhaps not.

Imagine the same bet where you knew it would be repeated 100 times. Would you take it now? You may well do so as the probability of making a gain suddenly looks higher.

This is all about how the brain works and is known as myopic risk aversion. There is a tendency to look at decisions in isolation and not apply prior knowledge.

When it comes to investments, sometimes people will temporarily forget that investments go up as well as down and will sell out at a loss. The more often they look at their portfolio, the more isolated decisions they are making.

This can be exaggerated by another concept know as prospect theory. We have a tendency to evaluate a situation using an assessment of the impact of potential losses and gains along the way but not with regard to the impact on the overall objective.

It has been proven that we are hurt more by a loss than we enjoy a gain. So for example, we know that winning a £1,000 is the same as winning £10,000 then losing £9,000 but most people would prefer the smoother path of the small win and no loss. Apply this to investments and we have a situation where some people feel happier with lower growth provided there is less volatility along the way.

People often only look at their investments when there is bad news and therefore will experience more losses than they will gains.  Some experts think that we as take less risk than we should as a result of all of this.

What can be done to beat the way your brain works? Very few of our clients called in during the recent market turbulence as they know we are investing for the long term. They expect to make considered decisions together with their adviser and in the meantime most of them do not look at their portfolios very often. If they do have concerns, talking them through will result in making better decisions.

Neil Sadler – Latest Blog Posts

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