Personal Investor: Investors can be their own worst enemies
People can scour balance sheets, read research reports or run algorithms when deciding where to invest – but in the end, all that logic could be wiped out by an enemy that is right between their ears.
The technical name for that enemy is cognitive biases, and they can really throw a retirement portfolio off track. A cognitive bias is basically an error in thinking related to a mish-mash of past experiences floating around in our memories that ultimately impact the decision-making process.
It’s something WealthBar CEO Tea Nicola has been paying close attention to during the recent spell of market volatility.
“At times like these, when markets are volatile, it really changes how you think,” she explained in a recent note. “Emotions creep in. For instance, a bias of loss aversion can make you want to cash out. And if you’ve been invested for a while, this can cause you to lose money.”
Here are a few cognitive biases she uses as examples that might be helpful for investors to identify before the March 1 RRSP contribution deadline:
Recency bias: Past performance is no guarantee of future returns but many investors act as though it is. Over time, as an asset rises in value, we can expect it to fall back down to the mean.
Confusing the familiar with the safe: Blockbuster, Nortel, Sears, Pan Am Airlines, Pets.com – they all seemed like big, safe companies to invest in at one time. But size and great branding is no guarantee of safety. From the original Fortune 500 list, relatively few even exist today.
Focusing on returns while ignoring the fees: A 2.2-per-cent average fee for a mutual fund can really dig into your long-term average return — particularly when there are options out there that could be a third of that fee.
Running with the herd: You want to be fearful when others are greedy and greedy when others are fearful (Thanks, Warren Buffett). By the time you put money into it, most of the gains have been realized and it might even be headed for a fall.
February is Your Money Month at BNN Bloomberg. For more stories and practical advice on how to employ your money wisely, visit our Personal Finance page.