Potentially harmful mindsets to adopt
With a market event like COVID-19, panic decisions and irrationality could have driven investor choice and behavior.
Investor behavior and biases
“When talking about behavioral finance, there are many (perhaps hundreds of) different biases, but the typical ones are loss aversion, overconfidence, confirmation biases, herding and anchoring,” said Sharon Moller, Financial Planning Coach at Old Mutual Wealth.
“Investment and fund managers are very aware of investor behavior, but a portfolio manager could limit this. What still gets in the way of clients being financially successful, however, is that they act irrationally in other areas around their money, for example, not saving enough, spending unnecessarily, disregarding financial plans, and cashing in investments out of fear,” added Moller.
The working of the brain
“When we are in a strong negative emotion because of the loss of money, the brain can have a similar reaction as it would when coming across real danger. The brain redirects resources in blood and oxygen from the part of the brain that engages with rational thinking to our extremities and then produces hormones such as cortisol and adrenaline, so we can flee or fight,” said Moller.
“If we could think rationally about the situation, we would most likely be too slow to react and end up dead or maimed. The biology is there to ensure our survival. What happens after the situation is what is important. The brain saves this moment of perceived danger as a memory, and with it, stores all the strong emotions we felt in the moment. If at any time after we notice the slightest indication of losing money, the brain recalls the fear we experienced from that previous situation of loss. It then searches for information to confirm the pending doom,” emphasised Moller.
“The information collected by the brain at this time could be based on perception or assumption. We add these assumptions to the story we are telling ourselves… connecting dots that are not even there. This reaction helps us make sense of something that we are perhaps fearful to think about and has us feeling out of control. To bring back some agency, we act out, withdraw our money or switch into another fund — even if it makes no sense to others,” continued Moller.
COVID-19 and investor behavior
By now most South Africans have been impacted, directly or otherwise, by COVID-19, most significantly by the loss or illness of loved ones, negative impact on finances, and the general anxieties that have accompanied this time.
“From an investor perspective, investors have been impacted by COVID-19 in different ways. We know that a large number of people experienced reduced or complete loss of income, while some experienced minimal impact. Either of these scenarios would have influenced an investor’s behavior,” said Gontse Tsatsi, Head of Retail Distribution at Old Mutual Investment Group.
“For those who became cash strapped, with less or no income, or those who were affected by increased costs related to family responsibilities — e.g., funerals, having to support people that have lost loved ones, or support people who have lost income — an option may have been to take from their medium- to long-term investments, which we know jeopardises one’s future goals,” added Tsatsi.
“Some may have needed to take out loans, which also affects achieving one’s goals and, perhaps more detrimental, can land one in a debt trap. Of the two, taking a loan is almost always worse than using your own money,” said Tsatsi.
“Those who have been minimally impacted would have continued to invest as before COVID-19 and are unlikely to have needed to withdraw from their investments. These individuals may also have increased the amount they could invest due to savings from the earlier, hard COVID-19 lockdowns,” continued Tsatsi.
A switch to risky assets
“We have not seen a switch to more risky assets take place due to COVID-19. Prior to the outbreak of COVID-19, most flows were going into offshore investments as this category provided growth. We also saw flows into income funds for those who were seeking protection from high market volatility; this is against the backdrop of multi-asset and local equity funds providing poor returns for approximately the past five years. Our offshore and income funds continued to fulfill their investment objectives during COVID-19, hence we saw limited switches,” said Tsatsi.
“When it comes to switching funds, this tends to be driven by people adopting a short-term focus to investing, instead of taking a long-term view on matters. People also tend to focus on returns rather than whether their comprehensive financial plan remains viable to meet their long-term goals. Additionally, some people get caught up in fads or social talk on which is the next best type of investment or fund,” added Tsatsi.
These are all potentially harmful mindsets to adopt and we caution investors to not fall into this type of thinking.
For those investors needing to make some kind of revision to their investment strategy, this should be done with great caution and be due to changing goals or personal circumstances, e.g. taking on more or less risk if their life stage changes, such as becoming parents, retiring, etc.
“In recent months, particularly during this period of dealing with the pandemic, we also saw increased investment into Responsible Investing/ESG funds. This could have been due to their offshore exposure (offering more growth) and solid risk management (in the context of volatile markets),” he added.
Lessons learnt
To avoid being impacted by an unplanned loss of income, clients should ensure an emergency fund is in place,” said Tsatsi. “An emergency fund is a lump sum of money set aside as a financial safety net for future mishaps or unexpected expenses. Clients should aim to invest at least three to six months of their total monthly expenses in the fund, in order to keep medium- to long-term investments and goals on track and avoiding taking on debt.”
“For an emergency fund, clients should avoid investment types that have lock in periods. The best type of investment is one that is liquid, meaning you can access your money at any time in cash. (e.g. unit trusts). If clients find themselves needing to use their emergency funds, they ought to replenish the funds. This doesn’t have to be an immediate or overnight replenishment but set out a clear plan and timeframe for this process,” concluded Tsatsi.
Writer’s thoughts:
Close and constant communication between the planner and the client, especially in times of volatile markets, is critical. Clients need support and guidance to avoid switching unnecessarily. Having said that, investors should also continue to read and educate themselves on investing successfully. Do you agree? Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts myra@fanews.co.za
