We are preprogramed to make wafty decisions when it comes to finance. If only we were more like Spock but our innate humanness lets us down.
We feel the pain of a loss more than twice as much as the benefit of a gain according to phycological research– We agonise over the loss of a £10 note while finding one would merely be pleasant rather than exquisite. If we get a £10 discount, we would be pleased, but not to the same extent we are peeved if charged a £10 penalty.
This human characteristic that phycologists call loss aversion is unhelpful when I am trying to encourage an investor that a recent and temporary loss of value is insignificant in the grand scheme of things.
We also take mental short cuts. We have to. It is necessary for survival. We chose a reference we know and make decisions based on that reference – we call it rule of thumb, common sense or gut instinct. The phycologists call it heuristics. Some of our shortcuts let us down because they don’t consider enough information and are influenced by our current environment and recent experiences.
These two things combine to make the desire to sell just at the time you should be buying a very powerful feeling which is counterintuitive to the economic reality.
If I ask you when you would expect to get the best bargain on swimsuits; spring or winter? You know the bargains are in the sale, after the summer demand has fallen off and prices are discounted in the sale.
If I ask you to buy an investment that has fallen in value because it’s gone out of favour would you recognise it as a bargain to be snapped up in a sale?
It amazes me how many intelligent people end up buying high and selling low when it comes to investments. These same women snaffle some awesome bargains and revamp their entire wardrobe at a fraction of the cost a less savvy shopper ends up paying.
Which of these is the comment of a savvy shopper?
I was listening to the radio just before you called and apparently the FTSE 100 has grown 800 points this year and I think I would like to buy some more units in the tracker fund while it’s doing well.
I heard on the news on the way here that FTSE 100 is down 30 points and continuing to fall so I want to sell my tracker fund.
Neither. Both are wafty thinking, but don’t blame yourself if you thought one was a good idea it only shows you are human, but we do need to channel out inner Vulcan and be more practical and analytical about our investment reactions.