'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.    

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.

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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.”