Research

Rational investing in an age of uncertainty

How to keep a cool head when global markets heat up.

When it comes to investing, even the most savvy of us fall prey to bias and emotional trades. So what triggers should you watch for?

Geopolitical events. Elections. Fear of bubbles. Panics.

Any one of these is enough to keep the average investor on edge with an itchy buy/sell trigger finger. But a growing body of psychological and financial theories called "behavioural finance" is showing that during uncertain times, it’s more important than ever to rely on available data and put aside emotion-fuelled investing.

This field of research which marries economics with biology and psychology studies certain types of investing decisions - including those made on emotional or speculative grounds, often made hastily without all the facts or because of what others are doing.

The lead-up to elections, for example, can be a time when investors can start to feel pressured to make decisions based on what might happen.

A pattern of behaviours

Behavioural finance theory identifies a number of behaviours that investors typically fall prey to. Herding, or following the crowd, is the tendency to flock into the same sectors or markets that others are gravitating toward.

Another behaviour is anchoring, where investors are slow to react to fundamental changes in economic, corporate or market developments because of an irrational attachment to a perceived value, even in the face of changing information.

Still another is called a recency bias, where investors believe that things that happened recently will continue. If the markets have been up, some investors project that forward, though there may be no fact-based data to back up that premise.

These types of behaviours explain why people tend to buy stocks after a long rally and sell after a long or sharp decline. Put in more general terms, behavioural finance is about separating the irrational mind from the rational mind. Unfortunately, as humanity is often irrational, the deck is typically stacked against us.

The role of a Financial Adviser

Behavioural finance theory can be used to help investors develop a greater understanding of how their minds work and to show them that their investment decisions shouldn't be driven by emotion, but rather by a coherent strategy. The goal is not to make them smarter, but to make them aware of basic human psychological shortcomings so they are less likely to undertake counterproductive actions. Or—at the very least—not to make snap judgments every time there is a potential trigger incident.

A good way to combat these kinds of knee-jerk decisions is to slow down thinking and separate fact from fiction. Another tool is to rely on someone who can look at markets with clarity, such as a Financial Adviser. A Financial Adviser can help filter your decisions, sounding the alarm on any that appear to be irrational. But for that to work, it requires candour about your priorities.

This first step is to align investments with values and goals rather than hunches. Having a concrete roadmap for investments removes some of the emotion and more-easily reveals irrational biases.

Finally, it's worth mentioning that it’s a mistake to assume that only novice investors can fall prey to poor decision making when it comes to investments. Even among sophisticated investors, once emotion takes hold, anyone can make irrational decisions. Biases affect everyone, because, in the end, we are all human.

Avoid the pitfalls of behavioural finance by calling your Morgan Stanley Financial Adviser today and working together to plan a detailed investment strategy based on your goals.

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