It’s an age-old and at times over-simplistic adage: buy low, sell high. But it exists for a reason, and research conducted by behavioural finance experts, Oxford Risk, shows just how much we might lose by choosing not to invest during the pandemic.
The company states that many retail investors make decisions on the basis of ’emotional comfort’, which they estimate costs your typical investor around 3% per year in returns – during an average year. Given the increased level of market volatility during the pandemic, however, they believe the level of emotional decision-making has increased ‘dramatically’, and so too has the potential cost of emotional investment.
In fact, Oxford Risk predicts that with many choosing to increase their cash allocation due to pandemic uncertainty, ‘reluctance’ to invest might cost retail investors between 4% and 5% per year in long-term returns.
The company adds that what it calls the ‘Behaviour Gap’ – losses due to timing decisions caused by investing more money when times are good for stock markets and less when they are not – costs investors an average of 1.5% to 2% a year over time.
Having built up an expertise in developing financial decision-making software, Oxford Risk states that wealth managers and financial advisors remain ‘ poorly equipped’ to deal with complexity, uncertainty, behavioural biases and the ’emotional and psychological roller-coaster ride’ their clients have faced during the COVID pandemic.
Speaking on emotional decision-making, Oxford Risk’s Head of Behavioural Finance, Greg B Davies, PhD, said that human conversations are vital during times of crisis, but added that better diagnostic tools are needed to assess clients’ personalities and ‘likely behavioural traits’. He says:
“The suitability processes of many wealth management businesses are typically too human heavy, inefficient, and front loaded to the beginning of the client relationship to keep up with rapidly changing client circumstances at scale during a crisis. Understanding of client financial personality is typically limited to risk profiling
– often badly – and subjective human assessment.”
“Very few wealth management propositions are using the sort of objective, science-based measures that are needed to provide a comprehensive picture of their clients. There is too much guesswork and not enough technology.”
The company adds that there are common behaviours that investors adopt during volatile periods, which include focusing too heavily on the present and on small details, and feeling compelled to take action when the best solution might be a mroe hands-off, patient approach. These behaviours can lead to underinvestment, selling low, and decreased diversification, as clients choose to invest in the familiar.
Oxford Risk has launched a free Market Emergency Survival Kit which allows retail investors to measure six key dimensions of financial personality, which the company has identified through extensive research into investor psychology and financial wellbeing. The service also provides personalised recommendations on how best to invest, which are based on the findings.
Speaking on the measures investors can take, Oxford Risk’s CEO< Marcus Quierin, PhD, comments:
“Many of these actions will mean that investors turn paper losses into real ones. If they don’t need to withdraw money for immediate expenses, then the losses are only virtual… until they panic and make them real.”
“The investments in the news are not your investments. Retail investors should avoid watching the markets day-to-day as this will only increase anxiety to no useful end, and make you feel like you should be doing something, without any useful guidance to what that should be. Long-term plans should be looked at through long-term lenses.”
Mr Quierin adds that investors should focus only on factors that they can control, and in turn might postpone discretionary spending, and use volatile periods as an opportunity to take stock of long-term financial plans. He finishes by saying that consumers would benefit from choosing to invest in the ‘risk premium’. Put simply: the long-term reward for owning shares that eventually weather every short-term risk that can be thrown at them.