Investment legend Warren Buffett famously encouraged investors to be ‘fearful when others are greedy, and greedy when others are fearful.’
But it’s hard to hold your nerve like the Sage of Omaha in these times of unprecedented uncertainty, when 30 per cent of the stock market’s value has been wiped away since the start of the year.
It feels impossible to know whether you should be buying, selling or holding that nerve, but experts say that the first step towards making the right decision is to learn about the human fear response – and then apply these lessons to your investment strategy.
Only human: Fear, as famously captured in Edvard Munch’s The Scream
Sian MacInnes is a chartered independent financial adviser with Burford-based Philip James Financial Services. She has spent the past couple of weeks reassuring clients.
She says: ‘Investors react to fear in much the same way as they do to other threats in their lives. Flight or fight. Unfortunately, they can’t fight the stock market so the natural instinct is to run away and withdraw all of their investments and capitalise their losses.’
Learning about so-called behavioural finance – the study of the influence of psychology on the behaviour of investors – will help you avoid making investment mistakes you will regret later when markets have calmed down.
Neil Bage is founder of behavioural finance consultancy Be-IQ in London. He says most investors are currently ‘blinded by fear’.
He adds: ‘It’s such a fluid and evolving situation and people don’t know when the market’s slide is going to stop. We’re in a position that we haven’t been in for a long, long time.’
At times like this, Bage says investors fall back on a series of decision-making behaviours that were honed long ago, when our ancestors were hunter-gatherers. ‘We’ve seen it in investing, and also in panic-buying on the high street,’ he says. ‘Fear kicks in biologically.’
Bage says that due to a phenomenon called ‘loss aversion’, which may have developed to keep our ancestors safe, we feel losses roughly twice as much as gains – meaning it is exceptionally painful when stock markets fall. It prevents us from making good decisions.
Investors, he says, combine this with other negative behaviours such as ‘regret aversion’, where we think about the worst possible outcome and then choose the option that best minimises that – rather then the most sensible choice.
Whether our behaviour prompts us to sell shares or to stockpile toilet paper, for example, Bage says we can beat it.
He says talking to an adviser or a trusted friend can help investors make clearer – and more rational – investment decisions. ‘Such advisers and friends can act like a counsellor or a therapist,’ he says.
Greg Davies, head of behavioural science at investment risk business Oxford Risk, agrees. He says: ‘There is a constant tension in all of us – between doing the sensible thing and doing what is comfortable. The need for emotional comfort often triumphs.’
While not losing your head is vital, there may also be investment opportunities – as long as you are careful.
Long-term view: As the Sage of Omaha says, ‘My favourite holding period is forever’
Lee Wild is head of equity strategy at wealth manager Interactive Investor. He says markets are more volatile now than at any time since the 2008 financial crisis.
He says: ‘Markets famously do not like uncertainty – and Covid-19 brings that in spades.’
He warns share prices will remain volatile for some time, adding: ‘You will rarely be able to pick the bottom of the market. Remember the words of economist John Maynard Keynes, ‘Markets can stay irrational longer than you can stay solvent.’ So be certain you have a long enough investment time frame to weather further short-term market declines.’
Bage suggests buying shares on a regular basis – preferably through a monthly investment plan.
He says: ‘That way, you’ll avoid the emotional difficulty of investing during times of extreme market volatility.’
He also says investors should avoid watching the market and constantly going online to look at the value of their investments. ‘I know it will make me feel bad, so I don’t do it,’ he says.
Oxford Risk’s Greg Davies urges investors not to sell investments in the current environment. He says: ‘If you do need to withdraw money from your investment portfolio, start with the cash and bonds.’
Be-IQ has a mobile phone app Beam – Self Awareness that runs through games to help you find out why you make the investment decisions you do – and how you can make better ones. It is free and available from the Apple Store if you have an Apple device. An Android version is not yet available.
Finally, take a long-term view. As the Sage of Omaha says: ‘My favourite holding period is forever.’
Wisdom like that will help your investments see out Covid-19.
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