The team at Korff Wealth would like to wish our clients, families and friends a happy, healthy and prosperous 2023!
Last year was certainly a challenging year for many reasons. As investors, we saw almost 20% wiped off global equities and bond markets. Thankfully, due to quality asset selection, a high level of diversification and overweight cash positions, our own portfolios have only seen a fraction of those drawdowns. Nevertheless, we acknowledge that losses (even on paper) are disconcerting.
It is well known in finance that investors fear losses 2-3 times more than we enjoy gains. This psychology explains a lot of human behaviour in everyday life. Indeed, it has been critical to our survival for thousands of years.
Risk aversion can be very important when hunting for food in foreign environments, constructing a dwelling and caring for our young. However, when it comes to investing in the modern world it often leads to chronic underperformance for several reasons, including:
Procrastination. Fear of loss causes us to put off financial decisions while waiting for the “perfect time”. The problem for pessimists is that day may never come, or may be so delayed that more damage is done by leaving their capital on the sidelines.
Financial media. Our inherent financial insecurity has created a multi-billion-dollar industry, motivated to exaggerate obscure financial data to feed our inherent fear that the financial world might end tomorrow and send us all bankrupt. This serves to make potential investors more anxious about the economy and our financial security, and ultimately invest less money and enjoy less financial gains.
Ignoring the facts. The Australian stock market has delivered average returns of over 10% for over a century (dividends re-invested). Over this period, only around 1 in 5 years produced negative returns. If you invested $10,000 in the Australian Stock Market in 1980 and re-invested the dividends, these facts would deliver you an investment worth around $850,000 today. These facts are hard to believe for many investors. Our fear of loss causes us to discount positive data even when we know it’s true.
Short term thinking. We invest our savings across our entire adult lives. For most of us, this is a 60 to 70 year timeframe. Yet how often do we make decisions based on short term data? The Australian stock market is down around 15% since April, which is not good news if you need to sell your entire share portfolio tomorrow. If you don’t, history indicates it is more probably a time to think about investing more.
Compounding losses. There’s only one thing worse than losing money, and that’s throwing good money after bad! Even when we know we have made a bad financial decision, we often stick our head in the sand in the hope the losses will miraculously disappear, rather than pull the knife out and stop the bleeding. Everyone makes mistakes. Face them, learn from them and move on.
Our fear of loss is instinctive, which makes it very hard to displace. However, to be successful investors it is critical to be aware of how this fear can cloud our judgment. We must filter out information which is designed to accentuate this fear and focus on facts and data to help us make good investment decisions.