The Star Wars epic may be one of the greatest movie series ever created, but it can also offer us some lessons on how to manage our investment behaviour when the market is volatile. Yoda said it best when he told a young Anakin, “patience you must have.”
For some investors, the recent market volatility has resulted in anxiety and concern. In this article, we’ve outlined some of the common pitfalls that lead to harmful investment decisions and explain that the most important variable in your investing success – and the only thing you can control – is your behaviour.
Don’t be a Darth Vader driven by emotions
Darth Vader is the ultimate example of someone who started off on the right track, but motivated by emotion ended up on the dark side. Many of us have common emotional behaviours which can threaten our financial security. Fear, greed, indecision and regret are the emotions most frequently linked to harmful investment decisions.
In the case of planning for your future, there is at least one tendency that we’ve all succumbed to on occasion. It’s the feeling of instant gratification that causes people to overemphasise immediate rewards at the expense of long-term needs.
You may recognise your own past decisions in a handful of other frequent behavioural tendencies.
1. Overconfidence in your prowess as market prophets can also be detrimental to making market profits. When markets advance enough to get the casual investor’s attention, many often start to think their success is the result of skill, rather than cyclical luck.
2. Obi-wan Kenobi was smart in his advice to a young Luke Skywalker when he told him, “your eyes can deceive you, don’t trust them." Many investors have a tendency to overweight recent events. It causes misguided decisions at both good times and bad, as fear and greed override long-term prudence. It’s reactive, not proactive, and the response often causes people to buy high for greed’s sake and sell low out of fear.
3. Investors often also fear loss more than they seek gain. Loss aversion makes it difficult to put your money to work outside of a “safe” investment (eg term deposits), even if that perceived safety means inflation may destroy your purchasing power over time. Loss aversion causes people to plan for worst-case scenarios to minimise losses rather than trying to maximise wealth.
How to become a super Jedi and avoid dark side behaviour
1. Determine your risk tolerance.
Are you an aggressive investor? Or more conservative? Can you tolerate wide swings in the market, or are you willing to accept potentially lower returns for lower volatility?
Determining your risk tolerance is one of the first steps you should take in setting out your investment plan.
2. Stay diversified.
The very point of diversification is to limit downside losses in difficult markets. If a market correction happens (such as what we’ve seen recently) and you’re properly diversified, you’ll be less likely to lose a substantial amount – and thus less likely to sell at the bottom.
3. Think long-term.
Shmi Skywalker (Anakin’s mother) was on to something when she said, “you can't stop change any more than you can stop the suns from setting.” It’s good to remember that markets will always change and to realise that in the history of share markets, very few individual events have had a meaningful impact on long-term returns. Not the assassination of President Kennedy, not the fall of the Berlin Wall, not 9/11, not the start of the wars in Iraq and Afghanistan. In each of these cases, the US share market (S&P 500) stood higher two years after the event occurred.
Broadly speaking, in time, markets tend to recover from events that may seem overwhelming in the near-term.
4. Get advice. Find yourself a Yoda.
With bumpy markets, fear is a natural reaction. One of the best ways to deal with it is to seek advice from the specialists. Having a plan in place means you’ll be less likely to deviate from it – even when markets test our emotions with wild swings. Much like Yoda, your financial planner will help to guide you in the right direction. Call us now on 02 4926 2300.