Dealing with your behavioural biases

Can I manage my own investments?

Can you manage your own investments successfully, or do your own instincts get in the way? All investors are prone to behavioural biases that can quietly, and sometimes seriously, damage their long-term returns. The important question is what, if anything, you can actually do about them.

In this video, James Norton of Vanguard Asset Management explains why you're unlikely ever to overcome your biases completely, since they're so deeply engrained in us, but why simply recognising that you have them is a powerful starting point. From there, he shares practical strategies for reducing the harm they can do.

You'll learn several techniques for keeping your behaviour in check. The first is to keep returning to your goals: reminding yourself why you invested and what your long-term objective is helps put short-term noise into perspective. The second is to keep simple notes whenever you make a big investment decision, recording what you did and why. Then, when you feel tempted to change your portfolio, perhaps shifting your bond and equity split out of euphoria or fear, you can revisit those original reasons. Nine times out of ten, Norton suggests, you'll conclude the change isn't necessary after all.

You'll also learn why having a clear, disciplined process matters, particularly a regular rebalancing routine. By periodically taking profits from holdings that have done well and topping up those that have lagged, you keep your risk at a level that's right for you. But perhaps the most effective safeguard of all is having an objective third party alongside you, whether a trusted friend or a professional adviser. Their real value shows at the emotional extremes: keeping you on track when your portfolio is down and you're feeling uncomfortable, and tempering the euphoria when things are going well by taking some profits and staying disciplined.

The takeaway: you can't eliminate your behavioural biases entirely, but the good news is that you can absolutely do something about them. With clear goals, a written record of your decisions, a disciplined rebalancing process, and ideally an objective partner, you can stop your own instincts from undermining your investment success.

Chapters / Key points

• Why all investors are prone to damaging behavioural biases
• Why you'll never fully overcome your biases, and why awareness still helps
• Keeping your long-term goals front of mind
• Why writing down the reasons for big decisions is so valuable
• Why most portfolio changes turn out to be unnecessary
• The discipline of a regular rebalancing process
• Why an objective third party is the most effective safeguard
• How an adviser adds value at moments of fear and euphoria

Transcript

Can I manage my own investments?

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 of 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 and 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?" Nine out of ten 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, 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 the time when advisers really add the value is when you're feeling uncomfortable or particularly joyful. You're feeling uncomfortable because you have a review 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: rebalance the portfolio, go through the checklist of sensible things. Likewise, if the portfolio is doing very well, just to temper the euphoria, actually take some of the profits, redeploy into 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.