How did your behavioural biases affect your wealth in 2020?
2020 saw the worst Bear Market (a stockmarket fall of over 20%) since the Credit Crunch in 2008.
Some people might feel 2020 was an incredibly difficult year for their long-term investments in things like pensions, ISAs and other investment wrappers. It certainly felt difficult ‘in the moment’ because we were being bombarded from pretty much every quarter with bad news affecting our wealth – Stock Markets plummeting, highest Government debt level since the Second World War, predictions of deep and prolonged recessions etc.
But it is the actions you took as a result of this ‘news’ that will have affected your wealth. Those of you who are already working with us or who will have heard us speak on the subject will have heard us say things like ‘the only time not to get off a rollercoaster that is too scary for you is part way through’!
The UK Stockmarket was down c.25% at various points throughout 2020 but has recovered somewhat to a fall of less than 10%. Those of us with a more globally spread portfolio have fared better with markets showing a positive return from the period 1st of January 2020 to March 2021. If you removed your money from the stockmarket through choice in the face of such an onslaught of negative market sentiment it is likely you will have crystalised your loss. If this was in part due to your behavioural biases in the midst of the uncertainty caused by the global pandemic you are not alone.
Cash holdings in the UK swelled by nearly £80 billion in the first half of 2020. With cash accounts currently offering such low-interest rates, it is estimated that UK households have missed out on £38 billion in potential investment returns.
Wanting to move out of a volatile stockmarket to the perceived safety of cash is a natural and indeed predictable reaction. Bear markets are however nothing new and you should develop a strategy to protect yourself against the behavioural biases that could threaten your wealth during future bear markets. Research from Vanguard shows there were 16 in the last 120 years so you could argue we should be expecting them. Part of our role for clients is to prepare them financially AND emotionally for market downturns.
A good number of you will have heard of Black Monday and associate it with stockmarket losses. It is true the world’s biggest stockmarket – the US S&P 500 – fell nearly 35% in October 1987, most of it on Monday the 19th of October hence the moniker. But did you know that if you just tuned out the noise throughout the year and compared the market on the 1st of January 1987 with the 31st of December 1987 you would actually have been UP 2%!
The people that ‘lose’ money in a bear market are those who cash in and an awful lot of that happened in 2020. Oxford Risk suggests that these behavioural biases could be hurting investors by an average of 1.5% to 2% a year over time.
From a financial planning perspective, the starting point should be a long term financial plan. This starts with you identifying your future financial goals and aspirations. You then plot how far towards these objectives your current planning will get you. This gives you a context for making financial decisions from the outset and it should be reviewed on a regular basis.
In practical terms clients will often conceptualise their wealth in three pots;
- The Security Pot for shorter term objectives and needs such as cashflow, emergency fund or upcoming one off expenditures.
- The Wealth Pot for medium to longer term objectives particularly securing their financial independence from work at some point.
- The Surplus Pot for excess money that is to be given away, speculated with, spent on luxuries. Or, if neglected(!), donated to the local authority or HMRC!
Having a financial plan and someone in your corner who you trust to help you with difficult financial decisions can seriously help you protect your wealth. Don’t let your behavioural biases negatively affect your financial future in 2021 and beyond.
For more information on this subject or any other areas you would like help on please contact us.
Please note: The article is for general information only and does not constitute advice.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.