Report explains costly errors that market participants make as they chase their long-term goals
It’s a case of same as it ever was. Investors remain most susceptible to emotional decisions and panic selling, according to finance professionals.
Dave Goodsell, executive director, Natixis Centre for Investor Insight, said that years on the front line of behavioural finance helping clients navigate market highs and lows means advisors are perfectly positioned to know what can work against investors as they pursue their long-term goals.
Goodsell said: “Financial professionals appear to be spot-on in their assessment of investor behaviour. Results from our own surveys of individuals in the US, along with industry fund flows, show that when it comes to these mistakes, many investors are guilty as charged. Consider how the evidence stacks up against them.
“Whatever you call it, panic selling, making emotional decisions, or focusing on short-term performance, it all adds up to the biggest mistake for investors.”
Results from the 2020 Natixis Global Survey of Financial Professionals reveal which missteps the pros believe are most costly.
1. Panic selling (93%)
As market volatility shot up and the S&P 500 losses reached 34% in March of this year, Natixis said that investors sold out of mutual fund positions to the tune of $327 billion in the US alone. It was a huge example of a knee-jerk reaction to sudden volatility as not only did those who sold lock in losses, but they also missed out on a 20% rebound in April.
Goodsell said: “It all hit an emotional hot button for many. Strategic Insight also reported that the perennial safe haven of money market funds took in $1 trillion in assets between January and May as investors sought refuge from the pandemic market. It all adds up to short-term decision-making. And while most investors think they are focused on the long term, eight out of 10 professionals say they are too focused on the short term.”
2. Market timing (50%)
The next significant error is investors’ fight or flight instinct, which kicks in when they see the potential for losing assets in a market downturn. On the flip side, many see a rising market and can be overcome by FOMO.
Goodsell explained that, in 2018, investors experienced some of the highest levels of volatility in a decade – and their flight instinct cost them dearly. October of 2018 brought the worst of it, and as the S&P 500 returned -6.84% for the month, investors racked up losses of -7.97% for the same month. In August, when the S&P delivered +3.26%, investors gained 1.87% on average.
He added: “Recent history shows that investors lose out when they give in to their timing instincts … bad timing added up to sub-par performance for many.”
3. Failing to recognize your own risk tolerance (45%)
How do investors actually react to extreme situations. Goodsell said: “Fifty-six per cent say they are willing to take on risk in order to get ahead. But when pushed, more than three-quarters say they really prefer safety over investment performance.”
4. Unrealistic return expectations (43%)
Despite a declared willingness to take on risk, many investors have “outrageous” return expectations. Natixis reported that, in 2019, investors said they expected returns of 10.9% above inflation over the long term. Professionals say 6.7% above inflation is more realistic. “That’s a 63% gap between perception and reality,” Goodsell concluded.
5. Taking on too much risk in pursuit of yield (25%)
With interest rates at all-time lows for more than a decade, many have been forced to look further afield for yield, and have added more and more risk to their portfolios as a result. Natixis reported that flows into high yield bonds had been negative through the first three months of 2020 – including almost $11 billion in outflows in March alone. But after the Fed cut rates by 150 basis points in March and April, flows into the category rebounded to positive inflows of $10 billion by May 31.
6. Failing to recognize the euphoria of an up market (25%)
Five years ago, the Natixis Center for Investor Insight collaborated with the Massachusetts Institute of Technology in an evaluation of investor behaviour. Presented with a scenario where the S&P gained 10% in six months, investors were much more likely to extrapolate continued gains and increase their investment. Advisors were contrarians, suggesting that it was actually time to lock in some of the gains by reducing equity allocations.
7. Focused on cost, not value (19%)
Advisors believe that investors see passive investments like index funds are cheaper but make big assumptions about how they perform.
Goodsell explained: “Nearly eight in 10 professionals say investors are unaware of the risks of passive. To prove them right, 64% of investors think passive is less risky and 71% think passive will protect them on the downside. Passive investments have no risk management. They are as risky as the market is, and up or down, they deliver market returns.”
8. Failing to consider the tax implication of investment decisions
Investors’ behaviour in periods of stress may actually trigger unintended taxable events. For example, a big sell-off in your portfolio could lock in gains at a time when markets are declining rapidly.
Goodsell said: “We’re only human and bound to make some mistakes sometimes. When markets get volatile, we get nervous. And it’s even more likely that we’ll be guilty of one of these mistakes. That’s why it’s critical to get professional help with your investments.”
