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Financial advisors see the good and bad in investor behavior: investors who set clear financial goals, establish a plan for achieving them and maintain that discipline over the long-term; and all the rest. But investors are human and humans make mistakes.
Having spoken with 2,400 financial advisors in 19 countries, a 2016 survey by Natixis revealed that the most common mistakes have little to do with selecting investments or managing a portfolio. More often than not, investors fall victim to human nature, making decisions based on irrational emotions, outsized expectations and poor planning.
1) Making emotional decisions
In volatile times like these, the impulse would be to make investment decisions based on fear, which may do more harm than good. More than half of investors worldwide in the survey have said they struggle to avoid emotional decisions when market shocks occur. Yet, investors should recognize that while markets may go down, they may also go up. These positive and negative movements can happen in quick succession or they can be many months apart.
2008 for example is seen as one very bad year in the stock market. While this period included some of the 30-worst performance days for the S&P 500, it also included some of the 30-best performing days. It shows that the instinct to run from a perceived threat may also limit exposure to potential opportunities.
2) Having unrealistic expectations
The expectations of investors often outpace that of professionals. Investing is an optimistic pursuit, but research shows that financial advisors are needed to provide a more realistic point of view. According to Natixis, investors on average expect annual returns to be 9.5% above inflation, while advisors expect returns of 5.8% – meaning investors’ expectations are 180% greater than the professionals.
Big goals can be good, but investors have to decide that they can weather the potential volatility that comes with it. Pursuing high levels of returns may mean investing in riskier asset classes, which can bring greater volatility and investors should be sure they can withstand it.
3) Ignore short-term market noise
Advisors say the biggest challenge to successfully implementing goals-based investment plans is managing investor performance expectations. It would seem that even if they evaluate performance in terms of reaching personal goals, as 72% of investors claim to be doing already, their ability to remain focused during short-term market events takes them off track.
Short-term thinking can be detrimental in good times and bad. The instinct to buy into the momentum of a rising market can be just as strong as the desire to flee a sinking market. In the end it is the kind of behavior that leads to buying high and selling low – and that is not a recipe for investment success. Goals-based investing, if investors can maintain the discipline necessary to implement it, is designed to avoid impulses and set a benchmark that is more meaningful to individual being on track to reach their long-term goals.
4) Not having a financial plan
Having a financial plan is seen as essential for investors working towards the ultimate goal of retirement to set their savings goals. But evidence shows that investors on average believe they will only need to replace 61% of their pre-retirement income, considerably lower than the 75-80% experts say is needed. Adding to that, it is concerning that 51% of investors say they have no clear financial goals and 63% say they have no financial plan at all.
While having a financial plan in place will not guarantee these problems will go away, it can help increase the likelihood that investors have them in mind as they set savings and investing goals and accumulate assets for retirement.
5) Not knowing how much risk you can really tolerate
In light of the global economic volatility of the last year, risk should be the first and foremost consideration when entering into an investment. When asked for their personal definition of risk, investors around the globe generally say “loss of wealth or assets.” This may seem clear and simple, but in fact risk is critical to investing. Making it work for you be deploying it efficiently to garner the desire returns is the challenge for investors.
For instance, when asked how they would respond to a stock market that has declined as much as 10% to 20% in a six month period, 42% of investors said they would do nothing, but almost the same number, 41%, said they would decrease their investment at least a little. Only 17% say they would see the down market as a buying opportunity and increase their investments to equities.
According to financial advisors and institutional investors, such moves are counter-intuitive. Half of financial advisors would in fact advise clients to increase their investments as the market falls, closer to the 71% of institutional investors who say they see market decline as a buying opportunity.
In volatile economic times, there is an impulse to make rash decisions. But investment is a long-term pursuit which requires discipline, and successful investors are almost always those who take a holistic view of their portfolio. Focusing on short-term market movements and hot products only deviates from a long-term commitment to sustainably maximizing returns and accumulating wealth. As such, knowing your risk tolerance and making a realistic long-term plan not only helps investors think about the future, but encourages them to make the right decisions in times of short-term volatility.
Madeline Ho is head of wholesale fund distribution, Asia Pacific and executive managing director, Singapore of Natixis Global Asset Management Singapore.
5 Jan 2017