Behavioural biases: Fear and greed - how they affect investment decisions

James Norton
3 July 2018

When it comes to successful investing, it is all about picking the right investments. But is that all there is to it?

While our success or failure as investors will largely be driven by what we buy, how we behave also has a significant impact.

Over the next six weeks on Moneywise’s blog, I will take a look at investor behaviour. Known as behavioural biases, they are ingrained in all of us. In fact, early man’s very survival was grounded in the acute instincts of fear and greed. When attacked, fear set in and triggered fight or flight reactions. And in an age when food was scarce, every opportunity was seized. Fear and greed played a vital part in the survival of man.

Today, if there’s a crisis, we take action. If a river’s about to burst its bank, you don’t stand by and watch your house flood. You build defences. However, while we are programmed to fix, mend, improve and meddle, investing is different. More often than not, when everyone around you is panicking, the correct course of action is to sit on your hands and do nothing.

Human nature is such that we tend to feel better when we do something. But although it sounds easy, even lazy or, as some financial professionals would have you believe, negligent, doing nothing is often the hardest thing to do. Imagine stock markets falling all around you (think back to the financial crisis) and everyone is selling. It’s natural to want to follow the crowd and join in. Prices may have fallen, 20%, 30% or even more very quickly and, naturally, you want to protect what you have left. Your friends have smugly told you that they sold a few days ago for a big loss, but the situation is even worse now. It takes real courage to do nothing.

But fast-forward a couple of years. You’ve benefited from the discipline of sticking with the plan. Stock markets have recovered and you are making money again. Meanwhile, your friends took their losses and have nursed their wounds. But have they got back into the market? Probably not. Waiting for markets to fall again, they most likely missed the boat.

Over the next few weeks I will look at more examples, or traps, of when we think we may be better than we actually are. And although we are unlikely to be able to fix these biases because they are hard-wired into us, simply understanding that they are there will help. I will also outline a number of actions that you can implement to provide yourself with the greatest chance of investment success.

James Norton is a senior investment planner at investment firm Vanguard UK.