- Needing to manage your own retirement income?
- Loss Aversion
- Fear of Missing Out (and jumping in all at once)
- Bandwagon Effect
- Optimism Bias
- Welcome to the new normal
Now while this might not interest some people now, the reality is we’re all being forced to take more interest in our money, our the returns in our superannuation funds and more responsibility to make our money stretch further in retirement (whatever that will look like) as more and more Australians face a self-funded retirement.
Needing to manage your own retirement income?
Due to growing super fund balances and asset test changes, a sizable majority of new Australian retirees won’t be entitled to the full age pension at the start of their retirement.
- A 2019 study reports 65 percent of 60 to 64-year-olds (42 percent of whom are already retired) are fully self-funded retirees and not accessing the government pension systems at all.
It's no surprise to suggest nobody likes to lose money.
But most people agree there can come a time when a bad investment is a bad deal and you need to know when you want to cut your losses and walk away.
- People struggling with loss aversion bias can become what can feel like being trapped in an irrational fear of loss, so they continue to tolerate what can be a negative return for no good reason other than their fear of not wanting to admit to losing money.
Loss aversion bias is a mindset where some people, so loss averse, will do anything to avoid a loss - even if it means following a failing investment down to a crash missing out on gains elsewhere. The fear can be to lose $100 is worse than to risk making $1,000 elsewhere.
This can be because the emotional consequences of loss are too painful for those with loss aversion bias to bear so many become ‘emotionally stuck’ to holding onto an underperforming investment for no good reasons other than their fear of loss.
While everyone's financial goals are different, not understanding the effect of a loss aversion bias could see you unwittingly missing out on returns because of an irrational fear of loss.
A strategy to help manage Loss Aversion
One way to avoid being unduly paralysed by this bias is to follow a strict stop-loss strategy. This is where you agree ahead of time to sell an investment if its value falls by a certain amount. This could help you cut your losses at an appropriate point rather than hanging onto declining assets for longer than you need to.
Fear of Missing Out (and jumping in all at once)
The fear of missing out (FOMO) also sees some investors buying into a sizable investment overnight and then risking a fall in the value of their new investment the day after. This can needlessly trigger buyers' remorse.
A strategy to help manage FOMO
Dollar-cost averaging (DCA) is an investment strategy where an investor divides up the total amount to be invested across regular periods of time a particular investment to help average out any fluctuations in the market costs over time reducing the impact of volatility on the overall purchase.
As the name suggests, the bandwagon effect refers to the investor herd mentality following the crowd rather than undertaking your own objective research into a particular investment.
Quote: Simply said, the bandwagon effect is a phenomenon where people do something primarily because other people are doing it.
- As more and more people jump on the bandwagon of a particular investment, investment prices can often become dramatically overvalued. When investors begin to realise this, panic selling ensues often resulting in sale prices for significantly less than the original purchase (or value) price.
Think you will never fall for this mindset? The history of the dot com boom and bust story might be a good reminder that people and their investments are not always rational. In response to this phenomenon, some investors might even follow a contrarian investment style where they purposefully go against previous market trends by selling when others are buying.
A strategy to help manage the Bandwagon Effect
Nothing helps slow down a knee jerk reaction like learning how to look for the triggers for such quick reactions and begin to develop your own attitudes to how much investment risk you're prepared to take before an opportunity arrives.
There is a reason why our habits are hard to break so it starts with taking a greater interest in your money, your investments and to learn more about our money and what makes us more life confident.
Some people find the thought of living in a totally random and chaotic world too overwhelming and can fall prey to the Optimism bias.
- Simply said, everything good has a downside and if you can't see that (or become comfortable with its possibility) you might also be falling prey to optimism bias.
This is where you overestimate the likelihood of success compared to the likelihood of failure and end up ignoring the potential pitfalls all because you’re feeling safer when you’re being overly optimistic about its prospects.
A strategy to help manage Optimism Bias
Make sure you know what your own risk appetite is and how (and why) you feel about the inevitable rise and falls in investment markets. (This is where talking with a financial adviser can help prompt that conversation).
- Take the time to deliberately consider the other side of the coin (the downside maybe) and the negative outcomes that could result.
- You’ll be more likely to make a realistic, rather than an emotional, decision.
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Welcome to the new normal
Investing and asset allocations can be a complex process and like all investments, there are risks to face, some known some unknowable; (pandemic anyone?)
- The value of investments and any income from them may go down as well as up and investors may not get back the amounts originally invested too.
- Either way, as the government continues to tinkler with the superannuation environment and push more and more Australians to take greater responsibility for their own retirement incomes, it's safer to begin your education now, rather than wait till later to become more confident with your money.
So if you're new to investing, or perhaps you're just starting to take more notice of your superannuation balance and investment allocations, getting to know more about how these common emotional reactions affect investment decisions can be a good place to start your journey.