Analyse this: Can you control your emotions?
Human nature can play an unwelcome role when making investment decisions. Research suggests that an innate need for emotional comfort has led average investors to forego 4-5% in returns each year by leaving their wealth in cash rather than investing in a diversified portfolio. This article, by our expert Emily Haisley, explores the intricacies of a topic which may have more significance to your portfolio than you realise.
In our whitepaper, “Overcoming the cost of being human”, we examined the full extent to which emotions can throw an investor’s strategy off track. At Barclays we focus heavily on this area because it plays a fundamental role in enhancing the client experience and improving their returns.
During a period of economic uncertainty, investors – both individual and institutional - can quickly become overly cautious and hesitant about the prospect of investment, especially when it comes to their cash. As our ‘selling your business’ article refers to, a number of global corporates have acted in exactly this way over recent years, choosing to sit on large stockpiles of cash during the worst of the downturn.
Regardless of whether you are an individual investor or a multinational conglomerate, is it ever right to sit tight and do nothing? And how exactly do you learn to set aside emotional concerns?
To risk or not to risk...
When we use our Behavioural Finance models to tailor the best strategy for each client, we often try to manage the ‘fear factor’ of making mistakes – a good example of this is when you measure the comparative emotional impact of losing or gaining money. Experts have shown that the pain of losing money is roughly twice as painful as the pleasure of gaining an equivalent amount. As a result, many investors shy away from investments that pay-off in the long run, due to a biased fear of loss in the short-term.
According to the whitepaper I referenced earlier, individuals often fail to see the potential long-term benefit of investing in a diversified portfolio, compared to holding cash. Even during the recent turbulent times in the markets, being invested has been a clear winner. Indeed, it is only in the depths of the most extreme crisis in living memory that the long-term returns of a diversified portfolio dipped slightly below those of cash, and as long as the investor didn’t sell in panic, this situation was very short-lived. It is important to note however that we always ask our clients to remember that past performance is never a guarantee of future performance, and investing always carries a risk of loss.
Whilst it is understandable that you worry about investing your cash during a recession – and potentially risk experiencing the pain associated with loss – the Investment Philosophy research which Barclays produces can be informative for recognising and evaluating your own reluctance.
Know thy client; Know thyself
Whilst our experts advise people of the costs of reluctance and seek to introduce portfolio safeguards to address it, we of course recognise that each client’s needs are different, and that everyone’s risk tolerance is unique. Risk Tolerance is addressed with a robust scientific measure but you can get a sense of your own appetite with our interactive ‘Balloon Test’.
We operate on the belief that it is essential to have objective measures of what makes each investor unique. In addition to reluctance to enter the market (Market Engagement), the level of risk desired once invested (Risk Tolerance), we also examine emotional reactions to market movements (Composure). Different investors respond differently over the market cycle, as they have different needs for short-term comfort. With this understanding, we are in a position to make bespoke changes to their portfolio solutions that provide the necessary short-term comfort intentionally, directly and efficiently.
If you would like more information about the themes in this article, and their relevance for your own situation, please do contact your Private Banker. We are constantly updating our research and I urge you to visit our interactive Investment Philosophy site for the latest news.
If you have questions relating to the articles, please contact your Private Banker.