How to avoid behaviour tax and raise your investment choice awareness
The idea of behaviour tax sounds far-fetched, but as it turns out, it isn’t. Paul Nixon, the head of behavioural finance at Momentum Investments, says behaviour tax refers to the rands and cents you lose when you make financial decisions based on emotions such as fear and loss aversion, or overconfidence, rather than the bare facts.
A recent Momentum Investments Sci-fi report, reviewing investment behaviour from October 2021 to the end of September last year, reveals that when it came to flexible investments, investors lost as much as R5-million in behaviour tax. To put that in context, behaviour tax since Covid has cost investors in flexible investments as much as R146-million. with a 15.96% decline to 24,098 behavioural switches. A behavioural switch is identified as a change in an investor’s risk preferences.
“Our emotions are significant drivers of our behaviour, and decisions around money are often accompanied by strong attitudes and beliefs,” Nixon says. Machine-learning algorithms identified four investment behaviour groups — the avoider, anxious, assertive and market timer.
Perhaps you can recognise your own knee-jerk reactions to market movements in one of these four archetypes as explained by Nixon:
- Avoider— low behaviour tax. You have a low appetite for risk and would rather avoid it altogether, preferring to stick to a conservative asset allocation.
- Market timer — high behaviour tax. You constantly move between funds in an attempt to “beat” the market and chase higher returns. Unfortunately, this is exactly the type of thinking that leads to high behaviour tax during periods of crisis and periods of fluctuating markets.
- Anxious — moderate behaviour tax. You have a low-risk appetite but unlike avoiders, who stay put, you tend to move out of fear when you think a fund or investment is underperforming. This category also tends to see high behaviour tax, particularly during growth periods, when you think you may be missing out on something.
- Assertive — moderate behaviour tax. You have high self-confidence when it comes to investing and prefer to make your own investment choices rather than relying on or seeking help from a financial adviser.
Getting to grips with your investment behaviour is not going to be an easy task. Identifying your typical investment archetype is the first step on a long journey towards becoming more self-aware and attuned to your own personal bias.
Just as changing your diet requires constant monitoring, your investment choices will have to be visited and revisited under the lens of an awareness of what drives your choices.
Five things you can do:
- Take the information out of the context in which it is presented, as the presentation can create illusions. A salesperson will seldom tell you what the product is not. They put the product in a narrow frame by telling you only about its benefits. However, your decision could change if the frame changes and you gain more information.
- Develop a rule-based plan that you can stick to. For example, “I will wait at least three months before making any portfolio changes when there is market turbulence.”
- Look for opportunities during a market crisis. Keeping a positive lens is less likely to make you reactive to downturns.
- Be aware of your mental accounting habits. People treat hard-earned money conservatively but tend to treat “easy” money or windfalls more recklessly.
- A common cognitive error is that of anchoring, where you become fixed on an idea. Often an investment product is sold with a projection value that is based on factors at the time of sale (such as inflation). The projected value is based on the assumption that you will not disinvest ahead of schedule. Investors can become fixed on this projected value and when the investment eventually pays out, this can lead to disappointment if factors, such as interest rates, have changed significantly.
An example of this would be a person who bought a property for R400,000 and then an estate agent valued the property at R1.5-million at a later stage. Several months after the valuation, the person receives an offer to purchase for R1.2-million. The typical reaction would be a reluctance to accept the offer despite the fact that the profit would be considerable. In this case, the seller is fixated on the figure of R1.5-million. You would be better off if you did not anchor on historic prices, perceptions or historic values. BM/DM