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Kirk Rice Blog

Investor BehaviourWritten on December 5, 2018 by Kirk Rice LLP

Investor Behaviour
Financial Services Questions

The Question:

Since interest rates dropped low I became an investor as I want my money to grow in value, however I am now very uncertain. Should I sell my portfolio and then return to the market when it reaches the bottom? Is this what investors do when they say sell high buy low?

Kirk Rice LLP answers:

Anchoring

Most of us tend to “anchor” on the first thing we see and all judgements after that are relative to that.

Think about when viewing properties to purchase your next home. Let’s assume you have selected 2 properties in your chosen area. The first property’s for sale price will influence how you see any others. You’ll go to a second and might decide it is in a better location, but in need of more work compared to the first one. You’ll figure it’s justifiable to put an offer on it because you feel it is worth more than the first one. What you don’t do is establish whether the first price was realistic and therefore that you are getting value for money.

We also see this type of bias in investing: if you have a 10% return last year you will be disappointed with a 5% return this year; if you had a negative return last year you’ll be very happy with a 5% return this year. As part of our regular reviews, we look at wider market issues and provide a perspective with which to compare the return achieved. Of course your appetite for investment risk and ability to withstand loss will mean your return will differ to other clients. If a good friend tells you they made 20% last year you will measure your own portfolio return by that, whereas you probably do not know how much risk they took, or what they would do to cope with a loss.

It is possible to have an investment strategy with published target returns, for example 2% above inflation. Returns cannot be guaranteed, but usually targets like this are an average taken over a 5 year period. We also consider the impact of charges as having a portfolio that grows at 2% above inflation sounds good, but you need to factor in initial advice costs and investment management fees to arrive at your real return. As part of your regular review the portfolio target and actual annualised returns should be considered.

Keep your long term goals in mind and analyse if they can be achieved by not investing.

Loss Aversion

Studies have shown we hate losing money more than we like winning it. Losing £50 is more painful than the enjoyment we feel at winning £50. In fact many people think they were overly cautious after such a win and think what could have been had they staked more money.

In an investment portfolio, the fear of negative returns means many people do not take enough risk in order to achieve their long term goals. During our client reviews, we look at modelling returns and demonstrating the real return that could be expected, and what that may mean for your goals.

During the last few months, clients have experienced wide fluctuations in the value of their portfolios at all levels of risk. Some are contemplating selling part or the whole portfolio to hold cash they will then reinvest at a time in the future. If you are thinking about your options please read on.

There is always great uncertainty in business and around the world and not all of it ever makes the news so you are only seeing a snapshot. When the news is dominated by Brexit and Trump, other stories just never get the coverage they should. The US has stated they will continue to raise interest rates and this will deter investors in shares and their value has fallen throughout this year.

We have seen many studies that explain that for longer time periods (more than 5 years) that equity portfolios provide better returns than any other asset class. Equity portfolios unfortunately go through irregular cycles of correction when falls in value can be more than 10%. However, timing the market to sell high and buy low using the cash has proven to be very difficult. It’s only with hindsight that we can tell when the market was at it’s highest and lowest points.

What happens if you have sold some shares and hold cash but markets start to rise strongly again, at what point are you going to buy back in to avoid amplifying your losses. So unless you have an unexpected need for cash you cannot raise anywhere else, then I do not think trying to time the markets is appropriate.

Remember your long-term goals

Taking the long term view (more than 10 years) most falls are blips, but if you are drawing an income the outcome can be very different to being in the accumulation phase when you are making regular savings. Someone relying on income from their portfolio should have a disciplined approach to these risks, and I would expect them to be able to manage without income during the worst investment periods.

If you are not comfortable with a portfolio that fluctuates in value by more than 15%pa, then you should tell your adviser and consider the alternatives. There are fixed term investments that guarantee the return of your money if the market falls; strategies that limit falls of more than 20% and smoothed investment returns that can be guaranteed.

If you are not able or willing to ride out these market phases you might be someone who is taking too much risk.

At your investment review discuss this with your adviser. Advisers have to confirm that the portfolio is suitable for you, taking into account your attitude to investment risk, ability to withstand losses and your overall financial security.

You must not rely on this article as investment advice based on your personal circumstances, nor as a recommendation to enter into any investment service or invest in any investment product. We strongly recommend that you seek independent financial advice before making any decisions.

You should not invest in any investment product or agree to receive any investment service unless you understand the nature of the contract you are entering into, and the extent of your exposure to risk.

All financial products carry risk as investment strategies involve uncertainty. Risk factors may occur simultaneously and may compound each other resulting in an unpredictable effect on the value of any investment. The value of investments and the income from them can fall as well as rise, and you might lose the original amount invested. Fluctuations in such value and income can result from factors such as market movements and variations in exchange rates. Past performance is not a reliable indicator of future results.

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Any reader interested in discussing investor behaviour for their own circumstances can telephone Graham Jennings in our Ascot office on 01344 875 000, James Moody in our Putney office on 020 8789 8588 or Tim Neale in our Fleet office on 01252 960 500 or alternatively email info@kirkrice.co.uk

Please note: advice is given for general guidance only and specific advice should be taken before acting on any of the suggestions made.

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