Brain strain … instincts can get in the way of sound investment decisions. Illustration: Simon Letch
While evolution equipped us with a brain for making quick decisions about whether to fight or flee a dangerous animal, the brain that protected us from instant death so long ago can lead us to make bad investment decisions.
We can be irrational and emotional creatures. But recognising the most common behavioural biases can help make us better investors.
Successful investing takes discipline, and it requires a plan - maybe not a detailed plan, but at least one that identifies some longer-term goals. That will help us stay the course and mitigate our tendency to focus on the short term. As well as taming our animal spirits, identifying goals and setting a course to get there will help us make more objective investment decisions.
Darren Cunneen of investment researcher Morningstar has recently written about common behavioural biases that can challenge even the savviest investor. There are three that are the most significant.
Overconfidence is one behavioural bias that can be very costly. Studies show that men are more likely to have an inflated view of their abilities than women. One of the problems of overconfidence is that investors think they don't need advice. Or they think they don't have to read widely on investing, and that by instinct and their own brilliance, they will make wise investment decisions. But hubris can lead us to not only buy in to high-risk investments, but also refuse to admit we were wrong and cut our losses.
Just as overconfidence can be damaging to our wealth, so can being too conservative and too averse to risk. That's understandable when riskier investments have had a tough time since the onset of the global financial crisis. But an exaggerated fear of losses can lead to missed investment opportunities. It could mean having too much of a portfolio in term deposits, for example, when having a bit more in risky investments, such as shares, could lead to better returns over the long term.
Another problem is inertia, whether not wanting to know or forever putting off making investment decisions. It could be laziness, or the investor could be prepared to put in the effort but remains confused about what to do. Doing nothing could mean a lower standard of living in retirement.
Most people are invested in their superannuation fund's ''balanced'' option. These usually lean largely towards shares. Superannuation fund members who don't have many years left in paid work don't have time to recover losses. They need to consider shifting to one of their superannuation fund's more conservative investment options, where there is less exposure to risky assets such as shares and property.
These behavioural biases are hard to avoid or mitigate completely as they are hard-wired into our brains. But just being aware of them and of how they can influence our decision making can help us invest more rationally and less emotionally, hopefully making us better off financially.