'Emotional' decisions of retail investors will cost them

Many of the investment decisions retail investors in Australia and around the world are made for emotional comfort during the pandemic, and an average year this typically costs them 3% in returns, behavioural finance experts Oxford Risk said.

According to the firm, many investors increased their allocation to cash during these volatile times for markets, and the cost of this ‘reluctance’ to invest was around 4% to 5% a year over the long-term. 

Additionally, it estimated that the cost of the ‘behaviour gap’ – losses due to timing decisions caused by investing more money when times were good for stock markets and less when they were not – i.e. buy high and sell low – was on average around 1.5% to 2% a year over time.    

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Greg Davies, head of behavioural finance, Oxford Risk said that the suitability processes of many wealth management businesses were typically too human heavy, inefficient, and front loaded to the beginning of the client relationship to keep up with rapidly changing client circumstances at scale during a crisis.

He stressed that very few wealth management propositions were using the objective, science-based measures that were needed to provide a comprehensive picture of their clients and “there was too much guesswork and not enough technology”.

“This means that assessment of client emotional proclivities is noisy, biased and prone to error… it is too subjective. This is not to advocate removing humans from the process – far from it – humans conversations are vital, particularly in a crisis, but advisers need to be assisted by better diagnostic tools enabling accurate assessment of the client’s personality and likely behavioural tendencies,” Davies said.

Marcus Quierin, Oxford Risk’s chief executive, added that retail investors should avoid watching the markets day-to-day as this would only increase anxiety to no useful end, and would make them feel like you should be doing something, without any useful guidance to what that should be while long-term plans should be looked at through long-term lenses.

“Many of these actions will mean that investors turn paper losses into real ones. If they don’t need to withdraw money for immediate expenses, then the losses are only virtual… until they panic and make them real,” he said.

“Finally, investors should focus on what they can control. It’s the most ancient advice there is, and still the most important. You can’t move the market or predict when it’s at the ‘bottom’ or the ‘top’. You can postpone discretionary spending and use tumultuous times as an opportunity to take stock of your long-term financial plans.

“And you can control the opportunity to benefit from the ‘risk premium’ – the long-term reward for owning shares that has eventually weathered every short-term storm yet.” 

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And where are these "better diagnostic tools enabling accurate assessment of the client’s personality and likely behavioural tendencies" Greg Davies?

Saving that loss of 1.5-2% pa in investment returns due to behavioural issues is a big part of the value of ongoing advice. Yet regulators are actively trying to discourage ongoing advice?

yes, because research shows the public ( and the regulators) all believe their super funds are taking preventative action with their money in times of peak overvaluation etc, when most are not.

Actually most super funds are taking action via regular rebalancing, as are most adviser managed portfolios. SMSFs generally are not.

Unfortunately the reaction of many unadvised consumers to overvaluation is to switch to a different super fund with a higher concentration of overvalued assets, as these will have the best short term performance figures. Unadvised consumers believe that recent short term performance is a great indicator of future performance. They believe that sticking to a long term strategy in spite of short term market fluctuations will lose them money. To paraphrase Warren Buffet "investment markets are a wealth transfer mechanism from the ignorant to the well advised".

So if I charge my clients 1% p.a. and don't cash them out during market downturns we have just proven the client is 0.5 - 1% better off each year after paying me?

No, but if you stop them from cashing out then yes. Same applies if you stop them from switching to an option with much higher allocation to equities straight after a sharp rise in equity markets. It will turn out to be money well spent by the client.

Some people will this sort of behavioural guidance shouldn't be necessary. In an ideal world they would be right. In an ideal world we shouldn't need armies or police or counsellors or dieticians or judges etc etc. Sometimes it's best to do what's necessary to make the real world better, rather than theorising about what should happen if the world was ideal.

This is why I like managed funds from quality fundies. they might take a clip on the upside, but they also save you a clip by managing the downside risk. Just continually put funds into good mutuals and they reward you over the long term. Especially when your closer to retirement.(my own general opinion). as well as having some money on a few index etfs, favourite equities, maybe a bit of defensive metals

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