If you thought the most important investment-related news story of 2016 so far was China, Brexit, Donald Trump, the oil price, or politicians’ tax return revelations, you’d have missed a point. It’s Leicester City FC and its first Premier League title.
Loss aversion.
I don’t make this statement to trivialise or belittle either the fortunes of our clients in uncertain markets or the success of a proud football club.
Our clients’ success is ours, given our goals are completely aligned with theirs: the creation of long-term value to assist them in meeting their future financial needs. And the conviction, patience and support shown by football fans could be a timely reminder of core values for struggling investors in tough times.
The reason I believe Leicester City’s story relates so closely to markets and investment is due to the behavioural psychology that those fortunes reveal.
It was Matthew Syed at The Times (The Game, Monday 14 March 2016) who first highlighted this parallel. Leicester City, in trying not to lose the race for the Premier League rather than playing to win it, was facing the challenge of loss aversion.
It’s the equivalent of an investor’s temptation to lock in gains too soon and become overly protective, or the counter-productive desire to avoid losses at all costs without understanding risk as manifested by volatility.
In the case of Leicester City, it has affected those fans cashing out on their start of season bets at 5,000-1. Locking in a gain becomes very tempting when so much is at stake and I don’t blame them for that.
Committing to the cause.
What investors need is assistance to differentiate when they are selling out of conviction, as opposed to the fear of losing a gain, and a reminder of the importance of a long-term financial plan that is a supplement to the CPF.
Loss aversion, first demonstrated by Amos Tversky and Daniel Kahneman, is the most pervasive of all behavioural biases, mainly because people have always had a tendency to prefer avoiding losses to acquiring gains.
For those who insist on trying to time the markets and sell at the first sign of increased volatility, here is the “Schroders 3 Step Journey to Rational Decision Making”:
- Take the Schroders incomeIQ test at http://www.schroders.co.uk/incomeIQ. Then use the results to make a (genuine) holistic financial plan.
- Remember that capacity for loss goes far beyond a number and an objective definition.
- “The easiest way to increase happiness is to control your use of time.” (Daniel Kahneman, Thinking, Fast and Slow, 2013) Your plan should include activities that can increase your overall life satisfaction – such as holidays, buying the finer things in life, or retiring overseas – and reduce the worry that loss aversion can cause.
Sticking by long-term tactics.
As individuals, we all make choices that sometimes don’t make sense – it’s human nature.
Mix in the fact that we are often over-confident in our own financial acumen (our recent research found that 65% of investors globally are confident in their ability to make sound investment decisions) and we have a potent, destructive force that can de-rail our long-term financial plans.
Our value fund managers frequently talk about their unemotional appraisal of risk and reward, and their conviction in the value style.
Leicester City has demonstrated that it has stuck to its long-term, tactical success with low squad turnover and an absence of fear as it beat loss aversion and emerged victorious in the title chase.
Similarly, Singaporeans should comprehensively plan and implement their independent life-long financial strategies as soon as possible. An early start can help overcome the fear of loss, and give you the confidence to focus on the potential long-term gains. Envision what your ideal retirement lifestyle would be like and implement an investment plan that can help you achieve this objective. This would be in contrast to worrying whether you will have enough for retirement and helps you avoid making rash decisions when facing short-term volatility. The same goal, but with a different psychological approach, can put you on a path to long-term success and can be the crucial difference in creating your desired outcome.
Stuart Podmore joined Schroder’s Financial Institutions and Strategic Accounts team in December 2015 as Investment Propositions Director. Prior to joining Schroders, he held positions at JP Morgan as a Fixed Income Client Portfolio Manager serving the EMEA Funds business and Head of UK Strategic Alliances within UK Fund Sales. He is a Chartered Alternative Investment Analyst (CAIA) Charter Holder and holds the Investment Management Certificate from the CFA Society of the UK.
