Joe Wiggins writes on his blog that it is at times of severe market stress that our worst behavioural impulses come to pass. Whilst the recent losses in the value of portfolios are undoubtedly painful; the poor decisions that we will make as a result of the torrid environment will likely prove more damaging to our long-term outcomes. Against such a turbulent market backdrop, which behavioural issues should we be most concerned about?

Myopic Loss Aversion: Short-term losses are difficult, but they are also an inevitable feature of investing in risky assets.  Indeed, the high long-term returns from equity investment are a consequence of their volatility and the potential for severe losses – to enjoy the benefit you must be behaviorally disposed to bearing exacting periods.  For most investors (particularly younger ones) it makes sense to reframe the issue – rather than markets falling precipitously we should think about the likelihood that long-term expected returns from risky assets are now materially higher.

Recency: Our obsession with recent and salient issues means that they overwhelm our thinking.   Whether it is trade wars, Brexit or coronavirus.   This is not to say that such issues are not important but from a long-term investment perspective they are less vital than we think and feel they are at the time.  Try to make investments on the basis that we have to leave them untouched and unseen for the next ten years.

Risk Perception We are poor at judging risks.  We are prone to ignoring certain threats whilst hugely overstating others.  Our judgement about the materiality of risk tends to be driven by its availability (how aware we are of it) and its emotional impact on us.  The coronavirus is a particularly harmful risk for investors both because the magnitude of the impact is highly uncertain and it is deeply salient.  We also need to be clear about what risks we are considering when making an investment decision – is it the risk of short-term losses, the risk of being whipsawed by volatile markets, or the risk of failing to meet our long-term objectives?

Overconfidence In the past three months everyone has become an expert in virology, despite having no previous grounding in the subject.  It is okay to have an opinion, but the vast majority of people are guessing, and nobody knows the near term market or economic impact of the virus.  We shouldn’t make investment decisions that suggest we do.  In these environments making sensible long-term investment decisions is highly likely to leave us looking foolish in the short-term.  This doesn’t mean, however, we should not make them.  The advantage of being able to invest for the long-term is at its greatest when it is the hardest thing to do.  The only way to benefit from this is to have a sensible investment plan that is clear about objectives and the decision-making process.

This is a summary of a couple of articles that I read over the weekend. Investors all over the world are worried about the volatility and spread of COVID 19 virus. Here are some sobering thoughts.

The Evidence-based Investor website reminds us that crashes and corrections are a feature of equity investing, but when they happen they can be hugely unsettling. At the time of writing, exchanges around the world have rallied after the worst day for markets for 33 years. But don’t be fooled. We could be in for plenty more stomach-churning volatility in the days and weeks ahead.

The problem is, no one can predict the future with any accuracy. It’s impossible to say quite how serious coronavirus will be, or what impact it will have on the economy, let alone the markets. And markets may rise or fall sharply from here for reasons that have nothing to do with COVID-19. Yes, there’s lots of bad news out there. And there’s bound to be more to come. But life goes on, and there should be rich rewards for investors who keep their long-term focus, diversify, control their costs and carry on investing what they can. Stay calm, wash your hands and don’t touch your face. Or your portfolio

Michael Batnick reminds investors that it is hard to stay calm and ignore the movement day after day and week after week, especially if the market keeps going lower. But, when this thing finally does end, there will be a rally so fast and so furious that it will leave the people who sold like a deer in the headlights. They won’t know what to do. The idea that people who sell out of fear will buy out of greed is misguided at best.

Batnick warns us that if you’re making drastic changes to your retirement fund, just stop. There is too much on the line. What you’re really doing is ensuring you’ll have less money in the future because you’re uncomfortable today. It’s OK to be uncomfortable, in fact, it is guaranteed that over the course of your investing life, you will feel this very same emotion half a dozen times, maybe many more. You can be worried about lower prices tomorrow and still confident in higher returns in the future. That should be the default setting right now.