Analyse this: lessons from the psychology of investing

Is it a valid assumption that we will invest in a different manner at a time of deep crisis?

Simon Russell is director of Behavioural Finance Australia and the author of Applying Behavioural Finance in Australia. Picture: Aaron Francis/The Australian

Simon Russell is director of Behavioural Finance Australia and the author of Applying Behavioural Finance in Australia.

A former Goldman Sachs analyst and MLC executive, he has been studying how the COVID crisis changes the psychology of investing.

Read on for a question and answer session with Wealth editor James Kirby:

Is it a valid assumption that we will invest in a different manner at a time of deep crisis?

During a crisis I would expect the same mix of psychological issues and biases, but with some taking greater prominence. For example, loss-aversion refers to the tendency for people to overweight the importance of losses in their decisions relative to gains. If you check your investments every day you will see them fall about 50 per cent of the time. If you check annually, because the market tends to rise most years, the chance of seeing a negative return diminishes. So in a crisis not only is volatility high, but because of the psychological forces related to loss-aversion and attention, the impact of that volatility on investors is likely to be higher still.

Can you explain the flood of new investors into the market during and after the March crash?

Given the coverage, unless you were on a desert island it was difficult for the March crash not to attract your attention. This, possibly combined with a good dose of new-investor overconfidence and the idea of making a fortune out of a market rebound, might have swayed some of these investors. Of course, some could go on to achieve these riches, but this outcome is less certain than it might seem, at least in the short term. Meanwhile, it is important for these investors not to overlook less attention-grabbing considerations, such as diversification and their long-term asset allocation.

Did you see evidence of panic — and from what quarters — in the crash?

If there was (and arguably still is) a reasonable possibility of a prolonged global recession or even depression, then one investor’s “panic selling” is another investor’s “prudent de-risking”. Each of us judges the behaviour of others through the lens of our own beliefs and expectations …

Major investment decisions made on the spur of the moment without taking the time to sleep on the decision or to seek counsel from a trusted adviser, peer or mentor are arguably more likely to be driven by panic than by reasoned analysis.

Would you expect investor bias to change in conditions such as a lockdown?

Different people seem to have had very different lockdown experiences depending on whether they are at home with small kids or perhaps enduring a second wave (as am I). However, one aspect of decision-making that might be relevant for many investors during a lockdown is having access to a diversity of information and perspectives.

Even more so than before, during lockdown an investor views the world through their screens. Do they use those screens to bolster their confidence by accessing more views and information that they already agree with? Or do they enrich their thinking by incorporating diverging views? When it comes to investing there are no prizes for being confident and wrong.

How would you read the early super rush where millions have taken out their savings?

Psychological research paints a pretty compelling picture of how people often prioritise the present over the future — hence the benefits of having a compulsory superannuation system that people can’t typically access until they retire. With that in mind, I’m somewhat concerned by data suggesting that some people have accessed their super to make discretionary purchases. Effectively they are prioritising today’s pleasures over their future retirement security.

It’s difficult to be critical without knowing people’s individual circumstances. Your super would have to perform extremely well to match the after-tax return you can get from paying off any interest-bearing credit card debt.

Looking ahead, what changes can we expect? Will investors take more comfort in ‘‘hard assets’’ — gold, property — they can see and feel?

If I was to create an investment I’d try to make it as tangible as possible, simply because it’s easier to attract people’s attention if they can see it, touch it, sleep within it, open their safe and watch it glisten, hang it on their wall and admire it, take it for a test drive on the weekend, or open a bottle of it on their wedding anniversary. Having said that, other psychological forces can powerfully influence investment decisions too. One such force is the power of narratives. Research shows that information that is presented with a plausible sounding causal narrative, despite its inherent uncertainty, tends to drive decision-making. The tech-related stocks that investors are fawning over have few tangible assets but make up for it with compelling (to some) investment narratives.

What is it we can learn specifically from behavioural finance now?

Behavioural finance research demonstrates that regardless of our level of knowledge we all have predictable fallibilities in our decision-making. Those fallibilities are often hidden from our conscious awareness; none of us feels like we are biased.

(But) they are evident to researchers when we are put in brain scanners, or have the hormone levels in our saliva tested, or have our eye movements tracked, or are asked to complete decision-making tasks in a psych lab, or when our real-world investment decisions are measured.

Many investors are already (indirectly) benefiting from behavioural finance. But they can do so directly by learning which decision-making traps apply in which contexts and can have which consequences.