It’s quite an odd feeling to be in the middle of an unfolding story. Especially one that’s drawing other events towards it like a black hole.
Yesterday’s market drop came on the back of significant action being taken following a Saudi-Russian oil price stand-off and, with nerves already on edge, we saw the biggest one-day fall in the FTSE for 12 years.
As virus fears continue there might well be more issues exacerbated by an already jumpy investor community. And it really shouldn’t surprise us - reacting instinctively and decisively is a hallmark of how investors naturally make decisions under pressure. But it’s rarely the right way to act in these situations.
Behavioural biases crop up most when tensions are high and emotion takes over. That’s why now is the time to recognise just how important it is to manage our own behaviour before we even look at a share price or a news headline. Here are three of the most common biases we experience in times of market stress and how we can combat them - you might be able to see yourself in a few of them.
We need reference points, scales, and data to frame how we should feel about what’s happening in the world. They give us context and help us interpret the narrative. But a constantly changing story like what we are currently seeing upsets that order and makes it more obvious that, despite what we tell ourselves, we just don’t know what’s happening.
What’s important here is that when we feel vulnerable we start to connect the dots ourselves in the hope of establishing a solid storyline, with varying levels of accuracy. This can prompt emotional buying and selling, void of any empirical truth - even though it looks justifiable.
The past week is a prime example of investors doing just that. Half-understandings and fear are driving a lot of decisions but there is a way to take these off the table entirely.
Once we remove the short-term frame, we can realise that coronavirus will soon be something we look back on, not something we will have to wade through for eternity. This is the context we need, not short-termism. Taking time to looking past it all is a skill we will thank ourselves for developing.
One of the biggest blockers to all of this is the constant treadmill of rolling news. The effect of a constant flow of information is that even when we want to act on the back of it, we can’t help but think of what’s around the corner, because we know someone’s just about to tell us. Of course, this can prevent rash decisions but it can also mean we get stuck in limbo, and never actually act.
It’s common for the next step to be a reflection on how we felt last time something like this happened, to guide how we can act this time round. But even this can fail us.
Declinism is a bias which prompts us to remember the past as better than it was, and predict the future to be worse than is likely.
It’s comforting to reflect on something that’s already happened because we have control over its legacy. Especially when we half-remember it and fill in the blanks later.
We can’t do this with the future so, to limit any negative effects, sometimes we predict the worst. At least then we can be pleasantly surprised.
Regardless, as investors we should be doing our best to be pragmatic and admit we simply cannot predict the future. Regularly investing plans, or at least drip-feeding money into the market, mean we take our own emotions out of the equation and simply average out the price we pay for assets throughout whatever saga is playing out.
The more information we gather, the less confident we are because we then realise how much is left to understand. This chimes with our framing bias because it can be hard to think about a time when we won’t be in the current situation - and the longer it extends the harder it gets.
To this end, it’s not about amassing information but applying wisdom. While there is still a lot left to learn as the coronavirus topic develops, we need to remember that, despite inevitable knock-on effects, it is a temporary phenomenon.
Keeping up to date with every minor development is impossible and mostly unnecessary. It does little to increase our understanding but increases the likelihood that we will invest rashly.
In short, we are primed to use our innate instinctive brain to reduce risk. But when we invest, we need to use our methodical, thoughtful brain to look to the long-term and stop the short-term reactions.
It’s not really about preventing ourselves slipping into the biases above because we can’t rely on our ability to spot them when emotion takes over. Rather, it’s about putting processes in place so that when we react emotionally, our undesirable actions have limited impact.
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.
Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.