09/12/20Has financial bias cost you money this year?
Stock markets in 2020 have been characterised by volatility and uncertainty. If you have made financial decisions based on your feeling towards this, it could have cost you money.
Whenever we make a decision, we have to weigh up the different options. While reasons and facts should be the basis for any decision you make, emotions play a role too. Where this happens when making financial decisions, this is called financial bias. It can mean you end up making decisions that are not appropriate for you.
In recent months, as markets have experienced volatility and economic uncertainty has featured in the news, this may have affected the decisions you have made too.
Moving to cash due to Covid-19 cost investors 3%
According to behavioural finance experts Oxford Risk, investors that responded to Covid-19 uncertainty by moving more of their wealth into cash could have missed out. By switching to cash for ‘emotional comfort’ it is calculated that investors have missed out on returns of 3% or more a year.
Separate research also suggests that investors moved more of their wealth into cash in response to Covid-19. In the first half of 2020, UK households put away £77 billion in cash, taking the total amount saved in cash accounts to £1.5 trillion. While a cash account to cover emergencies is advisable, it is estimated that nearly £1.2 trillion of this cash is not needed for contingencies.
With cash accounts currently offering low-interest rates, it is estimated that UK households have missed out on £38 billion in potential investment returns.
While investing does come with risk, it can help your money grow at a faster pace than when using a savings account. However, you need to invest with a long-term time frame, a minimum of five years. This provides an opportunity for short-term volatility to smooth out. Investing for a short period means there is a higher chance that you could lose money due to short-term downturns.
There are many reasons investors held more of their money in cash during the first half of this year. However, for some, financial bias will have played a role.
For example, information bias occurs when investors evaluate information, even if it does not relate to their situation. It makes it difficult to assess what information is relevant. The sheer amount of information can be overwhelming. During the pandemic, investors have been bombarded with news, forecasts and opinions about what will happen. With much of this coverage negative, it is natural that some investors will have had an emotional reaction and decided that cash was safer.
Trying to time the market provides an opportunity for financial bias
It is not just a trend that is having an impact due to Covid-19 either. When the markets are performing well, it can be tempting to increase how much of your wealth is invested. In contrast, it is common to want to move your money to ‘safety’ at times when markets are performing poorly or experiencing volatility.
However, this can mean you end up buying assets while prices are high and selling at low points. Oxford Risk estimates this type of financial bias can cost investors an average of 1.5% to 2% a year over time. Over a long-term investment strategy, financial bias can end up costing you significant sums.
While it can be tempting to move money in and out of investments to maximise returns, trying to time the market is difficult. As the above averages show, you are more likely to miss out on returns than to increase your portfolio’s value. For most investors, a long-term investment strategy is appropriate.
Minimising financial bias: Stick to your long-term plan
Creating a long-term plan based on your goals and sticking to it can help you minimise the impact of financial bias. That can be easier said than done, though, especially at times of uncertainty. Working with us can help you here. A financial planner will be able to help you understand your long-term financial positions and act as a second pair of eyes when you want to make changes. It can mean financial biases can be highlighted and discussed.
That does not mean you should never make changes to your financial plan. After all, circumstances and goals do change, and your financial plan may need to change to reflect this. However, this should be driven by long-term aspirations and be based on evidence.
Please contact us, if you would like to go through your financial plan and investment strategy.
Please note: The blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.