Is conventional investing throwing your finances off course?

In many situations we are expected to behave conventionally – being professional at work or queuing in an orderly fashion – behaviour that is practiced or accepted by the majority. These behaviours usually come as second nature, but in some situations, what feels like the obvious thing to do can actually be the wrong action to take. This can often be the case with investing.

Money is an emotional subject. Landing your first job, saving enough for a house deposit, grabbing a bargain in the sales, all make us feel good. Overpaying for car insurance or losing your wallet causes upset. We can’t help feeling these emotions, but what we can try to do is adjust the way we behave when we are emotional.

‘Behavioural finance’ is the term used to cover the study of how our emotions affect the financial decisions we make. A common emotion that affects decisions is ‘loss aversion’. This occurs when investors place more importance on losses than gains. A way to try to counter loss aversion is to concentrate on the facts.

Deal with the facts

The basics of investing are factual – you want to buy at the lowest possible price and sell at the highest, to maximise your profits. The difficulty is that this can go against our emotions.

When our savings or investments are going up in value we feel good about it and this can make us consider investing more to make the most of the situation. But this would be buying when prices are rising – which may lessen your potential gains.

If we lose money, this can be upsetting and distressing and the first instinct can often be a desire to get out of a bad situation. But getting out would mean selling when markets are falling – impacting your potential gains.

This is where having a diversified portfolio could be beneficial. At Schroders Personal Wealth, we believe that by holding a range of investments, you are not exposed to one single type of asset therefore your investment risk is reduced. This is known as diversification, which simply means not putting all of your investment eggs in one basket. The idea is to spread your risk exposure by investing across different asset classes.

Investing can be unpredictable, but by spreading your money you can be prepared for market ups and downs. With good financial advice, the benefits of diversification have the potential to pay off in the long run.

The long game can be less emotional

Long-term investing means setting out what your financial goals are and when you want to achieve them by. Having this timeline in mind means you could potentially ride out bumpy markets. Being aware that you have a long-term aim should help to beat the urge to sell when markets are falling, with the knowledge that at some point they are likely to recover. And having experienced this once, means you are more likely to recognise and more comfortable in ignoring the urge to sell in the future.

Financial markets are notoriously difficult to predict, and past patterns are not always repeated. However, we do know that markets are unlikely to keep falling indefinitely. If you are able to override the urge to ‘protect’ your investment when it is falling, you should eventually be rewarded when markets turn and start to rise. The value of investments and the income from them can fall as well as rise and are not guaranteed. The investor might not get back their initial investment.

Markets do go up and down – known as ‘volatility’, and sometimes the swings can be large, which can mean seeing your savings or investments lose a significant amount of value in a short space of time. This can be very unnerving – a natural emotion to feel about your hard-earned cash. But although there will inevitably be ups and downs, the overriding trend of financial markets over a long-term time horizon is usually upwards.

Contrarian investing

Contrarian means behaving to the contrary of what appears to be the appropriate action, or going against what the majority are doing. It can be extremely difficult to keep a cool head and not sell your investments when that seems to be what everyone else is doing.

Financial markets are dictated by human behaviour – the decisions of the collective to buy or sell at certain times. Contrary to the action of the majority, the best thing for your finances can sometimes be to behave in the opposite way. This doesn’t mean automatically choosing to do the opposite! Just being able to objectively assess the situation and not panic into buying or selling for FOMO – fear of missing out. Investing in the best interests of your finances can sometimes be contrary to the way the market is behaving.

You’re only human

It’s not always easy to control your emotions. It can be helpful to get a third party involved when it comes to your money, to remove the emotion. This could be in the form of a professional financial adviser, or delegating investment decisions to a fund manager, rather than making your own buy and sell investment decisions.

In either case, a long-term mind-set is usually sensible to avoid making knee-jerk emotional decisions.