Our behaviour is driven by emotions that are often affected by common biases which can lead to poor investment decisions. This can simply be illustrated by tossing a coin repeatedly. If you toss a coin 10 times and it lands as heads, what are the chances of another head on the 11th toss? When presented with information we interpret it according to our own biases, and then react to the information. Most of us are prone to drawing over-strong inferences from previous, especially recent events or trends. The first 10 tosses of the coin have no bearing on the 11th toss. There is still a 50% probability of a heads or tails.
Information overload is a daily occurrence. Psychologists and behaviour scientists’ research have shown that there are over 100 behaviour biases which lead to errors in judgement and irrational decision making. These include overconfidence, fear, greed and confirmation bias.
These biases influence our success in investing which cause us to act irrationally and destroy wealth. This is typical in times of volatile markets. In analysing seven previous market declines (crashes) it took an average of 2.6 years for investments to recover. If one panicked or acted irrationally during these declines, in all likelihood you would have lost money.
From the May 2008 crash of 45% it took the JSE All Share index, Allan Gray Equity fund and Allan Gray Balanced fund 2.5, 1.8 and 1.2 years respectively to recover their losses. Investors who did not succumb to their emotions would have made back their losses and would have more than doubled their money by 30 September 2016.
When the market crashed in 2008 the Allan Gray Stable fund returned a positive 3.2%, protecting capital for the risk averse investor that wants stability.
Stick to a long-term strategy that is tailored to your goals, time-horizon and risk profile. This will help to take emotion out of decision-making and avoid straying from your long-term strategy especially when markets are volatile.
Click here to read the full Allan Gray article: How to be a better long-term investor