Don’t let anchoring lower your returns
In recent times investors have become much more aware of how their behaviours affect the way they invest. It’s become clear that certain biases affect our investment choices. Being aware of these biases is one way to reduce any potential negative impact they may have.
‘Anchoring’ is one of the behaviours that investors display that can reduce their returns.
“Given the dramatic experience of the financial crisis of 2007/2008 and its aftermath, many investors have made emotional decisions about their assets. But this can lead to errors. Psychologists describe ‘anchoring’ as a mental shortcut in which recent memorable events are considered more likely to recur than probabilities suggest,” says Nader Naeimi, AMP Capital’s head of Dynamic Markets.
“For example, eight years into the post-GFC recovery, investors continue to make knee-jerk decisions in response to market turbulence, expecting another GFC is looming. This leads to a damaging investment approach of buying high and selling low. Yet objective analysis suggests another GFC is a low probability. Only with a disciplined investment approach backed by conviction and strongly-held investment principles can investors achieve financial success,” he adds.
Darren Howard, a specialist SMSF financial planner with Merit Planning East, explains that anchoring is the tendency to avoid losses, rather than look for gains.
“An investor may have invested in a particular stock and become anchored to that decision, even though the prospects for that stock don't look overly favourable. If they have suffered a loss they'll often sit on those losses in the hope of eventually getting their money back. A better approach might be to cut the losses and move funds to a new investment that’s a more attractive opportunity," he says.
Howard explains that anchoring is a subconscious human tendency and seeking professional advice can help avoid it. “If you seek expert advice, in conjunction with your own research, in many cases you'll be able to make a more balanced decision,” he notes.
Examples of anchoring
Anchoring doesn’t just apply to individual stocks. It can also happen with asset classes, for instance the share market. Let’s say an investor reads research to suggest the All Ordinaries index will rise to 6000 points by the end of 2017. If they enter the market and it moves upwards, this will confirm their view that the market will trade up. If they are anchored to the belief the market will continue rising, they may not take into account other information that tells them the market is poised to decline.
Conversely, an investor could equally read research that suggests the market will go down and decide not to invest in shares. Someone who is anchored to this view may decide to stay out of the market, even if strong evidence emerges to suggest that the market will rise.
Anchoring can also apply to investment strategies. For instance, an investor might hear from a friend or family member that superannuation is no longer an effective investment strategy after proposed changes limit how much money can be contributed to it.
The investor may take on this view, without getting all the facts, for instance information about the tax-effective nature of the super environment. In a worst-case scenario, the investor may be so anchored to this view they don’t take advantage of the benefits of the super system.
This could produce a negative outcome for the investor. A better approach is to draw on a diversity of sources that use quantitative data to form a view.
In all these cases, the fact the investor is attached to a certain viewpoint prompts a situation that is detrimental to their ability to create wealth. But there are ways for investors to pull up their anchors and invest more objectively.
Says Howard: “It's often a wise decision to have a plan in place regardless of which way the market moves. For example, if you wish to make an allocation to equities, and the market's currently sitting at 5450, and you think that the market's going to fall, it’s an idea to set an upper benchmark if the market moves against your analysis.”
He also notes that investors instinctively find it hard to sell when markets are rising and also balk at buying into a market when it’s dropping. “But this can be when some of the most mouth-watering investment opportunities become available.”
Above all, Howard says to avoid anchoring the best idea is to have a map or action plan so that regardless of what's happening in the market over the short term, investors are empowered to make a decision, rather than sit on the fence indefinitely.
The idea is to test your beliefs against real market data and have a pre-determined plan in place that guides your investment decisions under a number of different scenarios.
This is the best way to ensure anchoring and other behavioural biases don’t negatively impact your investment returns and instead you draw on objective information to make decisions about how you manage your wealth.
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