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For most investors, recent market volatility has resulted in heightened anxiety and concern. But counterproductive emotions can sometimes influence our decisions, and fear and greed can be difficult to ignore. Choosing the right investment mix is one of the key areas to focus on when planning for your retirement. So, how can you ensure your decisions stay consistent with your long-term goals?
We're all emotionally involved with our money at some level. Nobody is immune to factors that influence behaviour. Fear, greed, indecision and regret are the emotions most frequently linked to harmful investment decisions. They all render people susceptible to a variety of pitfalls.
In the case of planning for your future, there is at least one tendency that we've all succumbed to on occasion — the feeling of instant gratification that causes you to overemphasise immediate rewards at the expense of your long-term needs. In other words, assuming long-term financial commitments can be put off for another day. But in reality the earlier you start planning, the more options you are likely to have when you reach important life milestones.
Naïve diversification is a frequent contributor to unnecessary risk. This is usually the result of dividing up your money based on rules of thumb without taking into account your tolerance for risk or what the returns might be. The classic case is an investor holding several super funds that are all invested in a very similar way, (such as a Balanced fund) without understanding the overlap in them. You may not be as diversified as you thought you were, and may actually be better off simply consolidating your super into one fund and diversifying across the options available within your primary fund.
Overconfidence in our knowledge of markets can also be detrimental to making market profits. When markets advance enough to get the casual investor's attention, they can start to think their success is the result of skill, rather than cyclical luck. And sometimes, belief persistence causes us to ignore evidence or indicators that are contrary to what we may believe to be in our own best interest.
Another contributor to financial difficulties is the tendency to overweight recent events. It causes misguided decisions at both good times and bad, as fear and greed override long-term prudence. It's reactive, not proactive, and the response often causes people to buy high for greed's sake and sell low out of fear. This is why some investors move in and out of their investments at inopportune times, mistaking growing value for risk and vice versa.
Investors often also fear loss more than they seek gain. Loss aversion (strongly preferring to avoid a loss) makes it difficult to put your money to work outside a 'safe' investment (e.g. term deposits), even if that perceived safety means, inflation may destroy your purchasing power over time. It causes people to plan for worst-case scenarios to minimise losses rather than trying to maximise wealth.
Then there is the ultimate cause of going nowhere – fear of regret. And right now, fear is by far a more dominant feeling. Frequently, even when a clear course of action is appropriate, people prefer to do nothing or remain indecisive for fear of making the wrong decision.
Fear is a great motivator – but a bad guide. A better strategy is to stay calm. People who act coolly will make better decisions than those that act emotionally. At the end of the day, the only thing you can control is your behaviour.
If you would like to discuss your investment strategy within your super fund or need more information, please contact your financial adviser. If you do not have an adviser, we have a select group of financial advisers who we believe are best placed to provide our members with personal financial advice. To find an adviser in your area, please contact our Helpline on 1800 555 667 between 9am and 6pm, Monday to Friday.