The psychology of investing explained

Economic cycles include periods of growth and decline, and while downturns don’t usually last nearly as long as growth periods, they can be costly for investors.

The cost may not just be financial. Your peace of mind as well as your wealth may be at risk with the stress of seeing the value of your portfolio, and the capital you have worked hard to build up eroded.

Thanks to a combination of post-covid inflation and the effects of war in the Ukraine, we may be facing a global recession.

At Continuum we are looking at the psychological impact of being an investor in a downturn.

Why psychology matters

We are all only human. We believe that we think rationally, especially when it comes to making decisions about our money. In fact, psychology shows us that our emotions, biases and fears make rationality a rare commodity. 

Understanding three key cognitive biases of investors shows they can be particularly dangerous when a downturn makes investment decisions more challenging than usual. 

Understand loss aversion

We want to keep what we have. It is a fact of human psychology that we feel a loss much more than a gain.

This is known as ‘loss aversion’ by both psychologists and economists.

A market downturn can mean investors flee from risk, switching to low risk investments, or cashing out entirely. This may reduce volatility and losses, but it may mean missing out on opportunities. 

Riding out a downturn – including this one – may be a better tactic than trying to time the market. 

Understand recency bias

We know that investment should be a long game, but emotionally, we base our expectations on recent outcomes instead of long-term experience. This recency bias means that when our portfolio values fall, it’s difficult for us to remember that over the longer term, equity markets can go up despite being hit by crisis from time to time. On some primitive level we fear huge losses and the end of the investment world as we know it. 

If we panic and sell investments we crystalise losses, rather than simply waiting for markets to recover.

Understand herd mentality

We are social creatures, and tend to follow the herd, because we find it hard to believe that the majority could be wrong. 

The reality is that investments can easily become overvalued due to over optimism – or that we lose money by dumping our assets just because everyone else is doing so.

Making rash decisions or selling up when other people do so may be tempting – but in the current markets you have to stop and think. The majority may simply be wrong. 

Understand why you need a rational strategy

Fears about loss, panic and a tendency to follow the herd together add up the biggest problem of all about investing in a downturn. We become irrational, and we forget that investment needs a rational strategy. There are ways to profit from investment even in falling markets, and there are certainly sectors where losses will be minimised if they occur at all.

You need an investment strategy which will help you avoid the dangers and take full advantage of the possibilities

At Continuum our experts can combine a thorough understanding of the basics with a watch on the market. It means that we can help you plan the investment strategy you need now, and help you keep it current and performing as it should.

So what can you do?

A well-diversified portfolio and the support of a financial expert to help establish an investment plan based on sound principles, and your own objectives, timelines and tolerance for risk are all vital.

At Continuum we understand the psychology – and the practical side – of investing in a downturn. Call us for the expertise you need to make your investments work harder for you – downturn or not.

The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to suitable investment strategy, you should seek independent financial advice before embarking on any course of action.

The value of investments can fall as well as rise and you may get back less than you invested.

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