Seven deadly sins of investor behaviour

Behavioural finance is a discipline that draws on psychology to explain cognitive and emotional errors made by investors.

Here are some biases of which all investors should be aware.

HERDING

The market over recent months has been characterised by violent short-term trends. So it has been easy for investors to herd, that is, thoughtlessly to imitate others. December 2018 was the S&P 500 index’s steepest December decline since 1931 (-9.2%); and January 2019 its strongest start to a year since 1987 (+7.9%). Herding leads investors to panic and sell after market falls, and to become overconfident and buy at the top of rallies.

Take a calm, long-term perspective, and have confidence in judgments backed by evidence, even if temporarily contradicted by others’ short-term behaviour.

LOSS AVERSION

The pain of loss is felt more keenly than the pleasure of profit. This principle extends beyond finance: studies show that in interactions between married couples, it takes five kind comments to offset one critical comment. Loss aversion can lead investors to behave irrationally, and, after several years of low volatility prior to 2018, many have forgotten how to handle losses.

Try to adopt a broader view that sets losses in the context of overall profits.

CONFIRMATION BIAS

A focus on data that merely confirms previous beliefs. Such is the volume of information available to investors that it can be very difficult for them to avoid unconsciously filtering out data that would contradict their opinions.

ANCHORING

Anchoring is the tendency to rely heavily on one piece of information – often a reference point adopted at an early stage. An example is the belief that some asset classes, such as utilities equities, real estate equities, the yen, or gold, are all-weather safe havens. Yet during 2018, all the above were negatively correlated with the volatility index, indicating that they tended to fall when S&P 500 volatility spiked.

ENDOWMENT EFFECT

People tend to value something they own more highly than something they do not. This can lead to investors holding onto underperforming stocks for too long and failing to form a fair view of them.

Although stocks are legally rights to ownership in companies, they can be dominated by market- rather than company-specific factors.

CONSERVATISM

Beliefs are often insufficiently revised even when new evidence is presented.

OVERREACTION

An excessive emotional response can cause havoc. Even experienced investors can fall prey to overreaction, abandoning their investment process and taking irrational decisions after a period of underperformance, for example. Overreaction makes an interesting contrast with conservatism.

Try to keep faith in a sound, disciplined investment process – even during periods of short-term underperformance. Improvements to a proven investment process should be incremental and well-researched.

Source: Merian Global Investors

Getting the increases in UK state pension?

Uprating the state pension in countries where it is frozen would cost the government £3.1bn, according to new figures.

The Department for Work and Pensions (DWP) said that this relates to estimates between 2019/20 and 2023/24.

This comes after it revealed about 510,000 recipients of the UK state pension living overseas do not get annual increases.

The DWP outlined the strategy in its document entitled ‘Estimated costs of uprating state pension in frozen rate countries’.

It said: “The policy on uprating UK state pensions for overseas residents is that the annual index-linked increases are paid outside the UK where there is a legal requirement to do so.

Examples of this are where UK state pension recipients are living within the European Economic Area or where there is a reciprocal agreement between the UK and the host country that provides for uprating of the UK State Pension.”

Currently, many pensioners living in the UK have their state pension increased according to the triple-lock principle, by a minimum of 2.5%, the rate of inflation, or average earnings growth, whichever is the highest. The same applies to expat pensioners living in certain countries, such as the US, all European Union countries, Barbados, Bermuda and Israel.

However, pensioners living in countries such as Australia, Canada, New Zealand and South Africa have had their state pension frozen at the value it was at in the year they left the UK.

The government has been urged to correct this policy to allow increases for expats with frozen pensions, with more than 219,000 people signing a petition.