Once you have made an investment strategy, often doing nothing is the best course of action. Yet, it’s an approach that might be more difficult to stick to than you expect.
Investment markets often experience volatility, which could tempt investors to make decisions based on short-term emotions. These actions might not align with their strategy and could harm long-term growth.
Instead, trusting your strategy may yield higher returns over the long term. Indeed, a common financial adage is “the best investors are dead”. Rather than responding to news or short-term movements, inactive investors buy and hold assets.
On the surface, doing nothing seems like a simple investment strategy, but common financial biases can make it difficult to follow.
5 financial biases that could make doing nothing difficult
1. Action bias
A key bias that makes doing nothing challenging is action bias, which means investors favour taking fast, decisive steps over extensive planning.
As a result, doing nothing can feel negligent, rather than disciplined. Some investors might also experience a sense of lack of control if they’re not actively managing their investments. Consequently, you might feel as though you must do something, even if it could potentially harm long-term returns.
2. Loss aversion
Loss aversion theory suggests that investors feel the pain of a loss twice as intensely as the joy of gains. So, when markets fall, it can cause emotional discomfort that could push you to act. Doing nothing might compound your worries and make you feel as though you’re ignoring risks.
3. Recency bias
In many situations, people focus on the most recent events, including when considering investment performance. This is known as recency bias.
When markets fall, investors might expect them to continue doing so. This anticipation of further dips could lead investors to take action in an attempt to prevent further losses. While this might seem rational, if it’s not aligned with a strategy, it could turn paper losses into actual ones.
Similarly, recency bias could take hold when markets are performing well. When markets are up, investors might make financial decisions in the belief that the rally will continue, which could lead to some taking more risk than is appropriate for them.
4. Social pressure
Investors are exposed to constant social pressure, which could come from the news, social media, or friends. All these different opinions about what’s happening in investment markets and how you should respond could amplify the sense of urgency.
If you don’t react to social pressure, you might feel like you’re ignoring important information or missing out on a potentially lucrative opportunity. Again, it’s a form of bias that could prompt financial decisions that don’t align with your overall investment strategy or risk profile.
5. Present focus bias
Finally, present focus bias refers to the cognitive tendency to prioritise immediate rewards and the gratification that comes with them over long-term benefits. For investors, this can manifest as making adjustments to their portfolio in a bid to secure returns quickly.
Quickly turning your initial investment into a larger sum to help you reach your goals is an attractive prospect. However, for the average investor, investing should be approached with a long-term outlook that helps balance your goals with investment risk. As a result, the present focus bias could skew your perception of what you should be doing.
We could help you manage your investments
An outside perspective could help you identify when bias might be influencing your decisions. As a financial planner, we could offer this and work with you to create an investment strategy that’s tailored to your circumstances and goals. Please get in touch if you’d like to arrange a meeting.
Please note:
This article is for general information only and does not constitute advice. The information is aimed at individuals only.
All information is correct at the time of writing and is subject to change in the future.
The value of your investments (and any income from them) 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.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.