Question from Young Money reader: What measures can I put in place to help me weather the ups and downs of market hype? There are so many emotions at play. I’d like to stop thinking about investing all day – and make sure that managing my investments doesn’t feel like a full-time job.
Answer from Darryl Brown, an independent investment consultant and founder of You&Yours Financial in Toronto: Social media, influencers, online forums and even the financial-services industry itself are responsible for driving market hype. Why? Because it sells.
The industry thrives on pushing the emotional envelope and trying to convince investors that this is a game that can be played – and played to win. If we let the hype get to us, we’re the ones getting played.
So how do you shut out that noise? I like to start by arming my investor clients with a basic understanding of behavioural finance, which looks at the impact of emotions on how we make decisions with money. It’s a fascinating area, and recognizing the biases we are naturally prone to will make you a better investor. Here are a few of them.
Herding mentality and following the hot hand. These are both common tendencies for investors, and the two have been very obvious in recent months. Herding mentality is where we simply copy the investment decisions of others as opposed to conducting our own analysis of an investment. Following the hot hand is the erroneous belief that a person who has experienced successful outcomes in the past will keep doing so in the immediate future. In the investing world, we see the herding mentality and following the hot hand when investors go all-in on advice from portfolio managers or bloggers whose predictions have recently come to fruition.
The narrative fallacy is another behavioural investing error, which results from our desire for storytelling. There is an innate tendency to believe there are superior returns available for certain investments because they have a romantic story and not much else. The GameStop narrative was made all the more captivating because of an ironically named trading platform, Robinhood. So poetic.
Confirmation bias is something we see in all areas of regular life but especially with investment ideas. People seek out information that upholds their existing beliefs and ignore information that contradicts it. Social media and online forums are two places where investors can go to feel like they are always making the right decisions. The problem is that it limits their ability to see a mix of diverse and reasonable opinions and options.
Overconfidence bias is the tendency for investors to maintain an overly positive assessment of their own skills in selecting investments. I see this every day in clients – mostly dudes. Essentially, it’s an egotistical belief that one is always going to be better than average, and it can create an extremely dangerous cognitive bias when investing.
Illusion-of-control bias is another one, and it goes hand-in-hand with overconfidence. In general, it’s that people believe they have more control than they really do. It’s how we cope with the fragility of life. But it often works its way into investing mentalities, leading investors to believe situations are less risky than they actually are. If investors are unwilling or unable to identify risks and the prospect of variable investment returns, they end up in a never-ending cycle of trying to control outcomes when they simply cannot.
These biases lead to common mistakes, such as poorly diversified portfolios, unnecessary churn rates caused by excessive trading and totally unrealistic return expectations. Just knowing about these natural tendencies and predispositions can help you avoid investing hype. So the first step is to be self aware and to question your own first instincts against these common psychological pitfalls before making any money decisions.
More tangibly, I always recommend two things.
- Remove your online brokerage account from your mobile device. You simply don’t need that hair-trigger temptation in your pocket.
- Make an investment plan. Please. I cannot say this enough. It doesn’t need to be fancy, but at the very least, write down some basics to keep yourself in line.
Money is a hell of a motivator, and your judgment can be easily clouded if you don’t put a plan in place before you start. Set an asset allocation for yourself, with upper and lower thresholds for your individual holdings.
For example, let’s say you hold an asset like bitcoin. Before you purchase your position, set a plan. Say you want bitcoin to be 5 per cent of your overall portfolio allocation, decide you will rebalance your position if it exceeds 8 per cent or declines to below 2 per cent.
Do this before you get started, with a clear head, before you get emotionally entangled. By doing this with every position you hold in your portfolio, whether it is an individual stock, bond, exchange-traded fund or mutual fund, you set an investment framework that you can easily execute as markets fluctuate. With limits in place, you can still participate in market trends and ensure your decisions are based on what really matters for you and your investments.
Every year, or more often if you’d like, take the time to sit down and update your asset allocation and upper and lower thresholds – your holding limits. Again, nothing fancy. Base it on any changes to your broader financial situation and take a thoughtful pause to check yourself for internal biases. Boom! You’ve just created a sustainable framework for managing your portfolio – 100-per-cent hype-free.
Are you a young person with a question for our adviser? Send it to us.
You can also join the Young Money Facebook group.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.