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Behavioural biases can have a detrimental impact on investment returns



They’re so heavily engrained in us. However, just having the realisation that you’ve got those biases is a great starting point. So what can you do about them? James Norton from Vanguard Asset Management explains that just having the realisation that you’ve got those biases is a great starting point...

RP: All investors are prone to behavioural biases which can have a very detrimental impact on their investment returns. So what, if anything, can you do about them? Here’s James Norton from Vanguard Asset Management.

JN: So, I think, the first point to note is that you’re unlikely to ever overcome all your biases. They’re so heavily engrained in us. However, just having the realisation that you’ve got those biases is a great starting point.

RP: So ridding yourself if your biases is unrealistic. There are ways, though, of reducing the negative impact they have.

JN: The first one is to keep taking yourself back to your goals: ‘Why have I invested? What is the long-term goal?’ If you understand what the long-term goal is then that can really help put the short-term into focus.

The second thing I would do is when you make big investing decisions just take some simple notes: ‘What have you done and why have you done it?’ And then, when it comes to making a change to your portfolio, say you want to change the bond/equity split because of euphoria or market depression - or you want to buy a different fund for whatever reason - just go back to the reasons you set up your portfolio and why you made those decisions. The chances are, they were very sensible at the time and if you revisit those it will just help you think ‘Is this change really necessary?’ 9 out of 10 times it probably isn’t.

RP: Another way you can help minimise the damage caused by behavioural biases is to have a clear process — and stick to it.

JN: One of the best ways to do that is just the discipline of having a rebalancing process in place. And that is on a periodic basis, it can be once a year, it can be depending on market movements - different people believe in doing it differently. Just taking profits out of holdings that have done very well and topping up holdings that have done less well to keep that risk level at an appropriate level for you.

RP: But probably the most effective way to deal with biases is to have someone join you on your investment journey — an objective third party.

JN: You may have a friend, or it could be an adviser, you know, maybe someone you actually genuinely value paying to keep you on track and to help you make those difficult decisions. And they do tend to be difficult decisions because at a time when advisers really add the value is when you’re feeling uncomfortable or particularly joyful. You're feeling uncomfortable because you have a rearview meeting and your portfolio is down. And you won’t be happy, and the adviser won’t be particularly happy either. But actually keeping you on track then is a huge value-add to rebalance the portfolio, go through the checklist of sensible things. Likewise, if the portfolio is doing very well, just to temper in the euphoria, actually take some of the profits, redeploys and the fixed income and keep you on track.

RP: Again, you can’t eliminate your biases entirely. But the good news is that you can do something about them.

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